Addthis Arens Chapter08

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Audit Planning and

Analytical Procedures

Chapter 8

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Learning Objective 1

Discuss why adequate audit

planning is essential.

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Three Main Reasons for

Planning

1. To obtain sufficient appropriate evidence for the circumstances

2. To help keep audit costs reasonable

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Risk Terms

_{Acceptable audit risk}

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Planning an Audit and

Designing an Audit Approach

Accept client and perform initial audit planning.

Understand the client’s business and industry.

Assess client business risk.

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Planning an Audit and

Designing an Audit Approach

Set materiality and assess acceptable audit risk and inherent risk.

Understand internal control and assess control risk.

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Learning Objective 2

Make client acceptance decisions

and perform initial audit planning.

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Initial Audit Planning

1. Client acceptance and continuance

2. Identify client’s reasons for audit

3. Obtain an understanding with the client

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Learning Objective 3

Gain an understanding of the

client’s business and industry.

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Understanding of the Client’s

Business and Industry

Factors that have increased the importance of understanding the client’s business and industry:

_{Global operations}

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Understanding of the Client’s

Business and Industry

Industry and external environment Industry and external environment

Business operations and processes Business operations and processes

Management and governance

Objectives and strategies Objectives and strategies

Measurement and performance

Understand client’s business and industry

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Industry and External

Environment

Reasons for obtaining an understanding of the client’s industry and external environment:

1. Risks associated with specific industries 2. Inherent risks common to all clients in

certain industries

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Business Operations

and Processes

Factors the auditor should understand:

_{Major sources of revenue}

_{Key customers and suppliers} _{Sources of financing}

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Tour the Plant and Offices

By viewing the physical facilities, the auditor can asses physical

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Identify Related Parties

A related party is defined as an affiliated company, a principal owner of the client company, or any other party with which the client deals, where one of the parties can influence the management or

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Management and Governance

Management establishes the strategies and processes followed by the client’s business.

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Code of Ethics

In response to the Sarbanes-Oxley Act, the SEC now requires each public company to disclose whether is has adopted a code of ethics that applies to senior management.

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Client Objectives and Strategies

Strategies are approaches followed by the entity to achieve organizational objectives.

Auditors should understand client objectives.

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Measurement and Performance

The client’s 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}

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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 auditor’s primary concern?}

_{Material misstatements in the financial}

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Client’s Business, Risk, and

Risk of Material Misstatement

Understand client’s business and industry

Industry and external environment

Business operations and processes

Management and governance

Objectives and strategies Assess client business

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Sarbanes-Oxley Act

The Sarbanes-Oxley Act requires that management certify it has designed disclosure controls and procedures to ensure that material information about business risks is made known to them.

It also requires that management certify it has informed the auditor and audit

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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 company’s performance.

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Examples of Planning Analytical

Procedures

Liquidity activity ratio:

Inventory turnover 3.36 5.20

Ability to meet long-term obligations:

Debt to equity 1.73 2.51

Short-term debt-paying ability:

Current ratio 3.86 5.20

Client

Client IndustryIndustry Selected Ratios

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Summary of the Parts

of Auditing Planning

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Key Parts of Planning

Accept client and perform initial planning

_{New client acceptance and continuance}

_{Identify client’s reasons for audit}

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Key Parts of Planning

Understand the client’s business and industry

_{Understand client’s industry and external}

environment

_{Understand client’s operations, strategies,}

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Key Parts of Planning

_{Assess client business risk}

_{Evaluate management controls}

affecting business risk

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Key Parts of Planning

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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

1. Required in the planning phase

2. Often done during the testing phase 3. Required during the completion phase

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Timing and Purposes of

Analytical Procedures

(Required) Planning

Phase Purpose

Understand client’s industry and business Assess going concern

Indicate possible misstatements

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Learning Objective 7

Select the most appropriate

analytical procedure from

among the five major types.

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Five Types of Analytical

Procedures

Compare client data with:

1. Industry data

2. Similar prior-period data

3. Client-determined expected results 4. Auditor-determined expected results

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Compare Client and Industry

Data

Inventory turnover 3.4 3.5 3.9 3.4 Gross margin 26.3% 26.4% 27.3% 26.2%

Client

Client IndustryIndustry

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Compare Client Data with

Similar Prior Period Data

Net sales $143,086 100.0 $131,226 100.0 Cost of goods sold 103,241 72.1 94,876 72.3

Net sales

2008

Net sales

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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}

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Short-term Debt-paying Ability

Current ratio Current assets Current liabilities =

Cash ratio (Cash + Marketable securities) Current liabilities

=

Quick ratio

(Cash + Marketable securities + Net accounts receivable)

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Liquidity Activity Ratios

Accounts receivable turnover

Net sales

Average gross receivables =

Days to collect receivable

365 days

Accounts receivable turnover =

Inventory turnover

Cost of goods sold

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Ability to Meet Long-term Debt

Obligation

Debt to equity Total liabilities Total equity =

Times interest earned

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Profitability Ratios

Earnings per share

Net income

Average common shares outstanding =

Gross profit percent

(Net sales – Cost of goods sold) Net sales

=

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Profitability Ratios

Return on common equity

(Income before taxes – Preferred dividends)

Average stockholders’ equity

Average stockholders’ equity =

Return on assets

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Summary of Analytical

Procedures

They involve the computation of ratios and other comparisons of recorded

amounts to auditor expectations.

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