Audit Planning and Analytical Procedures

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Audit Planning andAnalytical Procedures

• Chapter 8

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Learning Objective 1
Discuss why adequate audit planning is essential.
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Planning
The work is to be adequately planned,
and assistants, if any, are to be properly
supervised.
Acceptable audit risk
Inherent risk
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Planning an Audit and Designing an Approach
Assess client business risk
Accept client and perform initial audit planning
Understand the clients business and industry
Perform preliminary analytical procedures
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Planning an Audit and Designing an Approach
Set materiality, and assess acceptable audit risk
and inherent risk
Understand internal control and assess control
risk
Develop overall audit plan and audit program
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Learning Objective 2
Make client acceptance decisions and
perform initial audit planning.
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Initial Audit Planning
Should the auditor accept a new client?
Identify why the client wants or needs an audit.
Obtain an understanding with the client.
Select staff for the engagement.
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Learning Objective 3
Gain an understanding of the clients business
and industry.
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Understanding of the Clients Business and
Industry
Understand Clients Business and Industry
Industry and External Environment
Business Operations and Processes
Management and Governance
Objectives and Strategies
Measurement and Performance
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Understanding of the Clients Business and
Industry
What are some factors that have increased the
importance of understanding the clients business
and industry?
Information technology
Global operations
Human capital
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Industry and External Environment
What are some reasons for obtaining an
understanding of the clients industry and
external environment?
Risks associated with specific industries
Inherent risks common to all clients in certain
industries
Unique accounting requirements
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Business Operationsand Processes
Factors the auditor should understand
major sources of revenue
sources of revenue
key customers and suppliers
sources of financing
information about related parties
ability to obtain financing
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Management and Governance
Management establishes the strategies
and processes followed by the clients business.
Governance includes the clients
organizational structure, as well as the
activities of the board of directors and the
audit committee.
Corporate charter and bylaws
Minutes of meetings
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Client Objectivesand Strategies
Strategies are approaches followed by the entity
to achieve organizational objectives.
Auditors should understand client objectives.
Financial reporting reliability
Effectiveness and efficiency of operations
Compliance with laws and regulations
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Measurement and Performance
The clients performance measurement
system includes key performance indicators.
Examples
market share
sales per employee
unit sales growth
Web site visitors
same-store sales
sales/square foot
Performance measurement includes ratio
analysis and benchmarking against key competitors.
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Learning Objective 4
Assess client business risk.
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Assess Client Business Risk
Client business risk is the risk that the client
will fail to achieve its objectives.
What is the auditors primary concern?
material misstatement of the financial statement
s due to client business risk
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The Clients Business, Risk, andAuditors Risk
Assessment
Industry and External Environment
Understand Clients Business and Industry
Business Operations and Processes
Management and Governance
Objectives and Strategies
Assess Client Business Risk
Measurement and Performance
Assess Risk of Material Misstatements
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Learning Objective 5
Perform preliminary analytical procedures.
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Preliminary Analytical Procedures
Comparison of client ratios to industry or
competitor benchmarks provides an indication of
the companys performance.
Analytical procedures are also an important part
of testing throughout the audit.
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Examples of Planning Analytical Procedures
Client
Industry
Selected Ratios
Short-Term Debt-Paying Ability Current ratio
3.86
5.20
Liquidity Activity Ratio Inventory turnover
3.46
5.20
Ability to Meet Long-Term Obligations Debt to
equity
1.73
2.51
Profitability Return on assets
0.09
0.09
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Summary of the Purposesof Auditing Planning
A major purpose is to gain an understanding of
the clients business and industry.
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Key Parts of Planning
Accept Client and Perform Initial Planning
New client acceptance and continuance
Obtain an understanding with client
Identify clients reasons for the audit
Staff the engagement
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Key Parts of Planning
Understand the Clients Business and Industry
Understand clients industry and
external environment
Understand clients operations, strategies,
and performance system
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Key Parts of Planning
Assess Client Business Risk
Assess client business risk
Assess risk of material misstatements
Evaluate management business controls affecting
business risk
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Key Parts of Planning
Perform Preliminary Analytical Procedures
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Learning Objective 6
State the purposes of analytical procedures and
the timing of each purpose.
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Analytical Procedures
Analytical procedures use comparisons
and relationships to assess whether
account balances or other data appear reasonable.
SAS 56 emphasizes the expectations developed by
the auditor.
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Timing and Purpose of Analytical Procedures
(Required) Planning Phase
Purpose
Understand clients industry and business
Primary purpose
Assess going concern
Secondary purpose
Indicate possible misstatements (attention
directing)
Primary purpose
Reduce detailed tests
Secondary purpose
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Timing and Purpose of Analytical Procedures
Testing Phase
Purpose
Understand clients industry and business
Assess going concern
Indicate possible misstatements (attention
directing)
Secondary purpose
Reduce detailed tests
Primary purpose
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Timing and Purpose of Analytical Procedures
(Required) Completion Phase
Purpose
Understand clients industry and business
Access going concern
Secondary purpose
Indicate possible misstatements (attention
directing)
Primary purpose
Reduce detailed tests
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Learning Objective 7
Select the most appropriate analytical procedure
from among the five major types.
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Five Major Types ofAnalytical Procedures

1. Compare client and industry data.
2. Compare client data with similar prior-period
   data.
3. Compare client data with client-determined
   expected results.
4. Compare client data with auditor-determined
   expected results.
5. Compare client data with expected results, using
   nonfinancial data.

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Compare Clientand Industry Data
Client Industry 2002 2
001 2002 2001 Inventory turnover 3.4
3.5 3.9 3.4 Gross margin percent 26.3 26.4
27.3 26.2
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Compare Client Data With Similar Prior-period Data
2002 2001 (000,000)
of (000,000) of Preliminary Net
Sales Audited Net Sales Net sales 143 100
131 100 Cost of goods sold 103 72 95
72 Gross profit 40 28 36 28 S
A 32 22 30 23 Other
4 3 3 3 Net income 4
3 3 2
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Learning Objective 8
Compute common financial ratios.
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Common Financial Ratios
Short-term debt-paying ability
Liquidity activity ratios
Ability to meet long-term debt obligations
Profitability ratios
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Short-termDebt-paying Ability
Cash ratio (Cash Marketable securities)
Current liabilities
Quick ratio (Cash Marketable securities Net
accounts receivable) Current liabilities
Current ratio Current assets Current
liabilities
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Liquidity Activity Ratios
Accounts receivable turnover Net sales Average
gross receivables
Days to collect receivables 365 days Accounts
receivable turnover
Inventory turnover Cost of goods sold Average
inventory
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Liquidity Activity Ratios
Days to sell inventory 365 days inventory
turnover
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Ability to Meet Long-term Debt Obligation
Debt to equity Total liabilities Total equity
Times interest earned Operating income
Interest expense
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Summary of Analytical Procedures
They involve the computation of ratios and other
comparisons of recorded amounts to auditor
expectations.
They are used in planning to understand the
clients business and industry.
They are used throughout the audit to
identify possible misstatements, reduce detailed
tests, and to assess going-concern issues.
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