©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 8 - 1 Audit Planning and Analytical Procedures

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 8 - 1

Audit Planning andAudit Planning andAnalytical ProceduresAnalytical ProceduresAudit Planning andAudit Planning and

Analytical ProceduresAnalytical Procedures


Acceptance of ClientsAcceptance of ClientsAcceptance of ClientsAcceptance of ClientsJuan M. Garcia MercedJuan M. Garcia Merced

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 8 - 8 - 33

First Standard of Field Work

The work is to be adequately planned, and assistants, if any, are to be properly supervised.


Obtaining ClientsThrough:AcquisitionsBusiness contactsSocial contactsAdvertising


Auditor’s Business Risk

A thoroughly investigation of prospective clients should be made.


Submitting a Proposal

Should include:Nature of servicesQualificationsFees & other informationAudit committee


Communication with Predecessor Auditor

The successor auditor must ask management to authorize the predecessor to respond fully.

Key issue in deciding whether to accept the engagement.


Auditor inquiries will include:

• Disagreements with management over accounting principles or scope limitations

• The predecessor’s understanding for the change in auditors

• The integrity of management• Communications with audit

committees regarding important audit issues


Items Included in Engagement Letters

• Name of the entity• Management responsibilities

– Financial statements– Establishing effective internal control over financial reporting– Compliance with laws and regulations– Making records available to the auditors– Providing written representations at end of the audit, including that

adjustments discovered by the auditors and not recorded to the financials are not material

• Auditor responsibilities– Conducting an audit in accordance with GAAS– Obtaining an understanding of internal control to plan audit

and to determine the nature, timing and extent of procedures– Making communications required by GAAS


Engagement Letters--Optional Items• Arrangements regarding

– Conduct of the audit (e.g., timing, client assistance)

– Use of specialists or internal auditors

– Obtaining information from predecessor auditors

– Fees and billing• Other services to be provided,

such as examination of internal control over financial reporting

• Limitation of or other arrangements regarding liability of auditors or client

• Conditions under which access to the auditors’ working papers may be granted to others


ENGAGEMENT ENGAGEMENT LETTERLETTER

ENGAGEMENT ENGAGEMENT LETTERLETTER

Required!!!!!!!!!!!!!!!Required!!!!!!!!!!!!!!!


Generally Accepted Auditing Standards

• General– Technical training and efficiency– Independence– Due professional care

• Field Work– Planning and supervision– Internal control– Evidence

• Reporting– GAAP– Disclosure– Opinion– Consistency


Audit Planning• Gain an understanding of the• client’s business and industry.


Business Operationsand Processes

Factors the auditor should understand:

Major sources of revenue Key customers and suppliers Sources of financing Information about related parties


Tour the Plant and Offices

By viewing the physical facilities, the auditor can asses physical safeguards over assets and interpretaccounting data related to assets.


Management and Governance

Management establishes the strategies andprocesses followed by the client’s business.

Governance includes the client’s organizationalstructure, as well as the activities of the boardof directors and the audit committee.

Corporate charter and bylaws

Meeting minutes

Code of ethics


Measurement and Performance

The client’s performance measurement systemincludes 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 analysisand benchmarking against key competitors.


Assess Client Business Risk

Client business risk is the risk that theclient will fail to achieve its objectives.

What is the auditor’s primary concern?

Material misstatements in the financialstatements due to client business risk


Perform preliminary analytical

procedures.


Preliminary Analytical Procedures

Comparison of client ratios to industryor competitor benchmarks provides anindication of the company’s performance.

Preliminary tests can reveal unusualchanges in ratios.


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

Profitability ratio:Profit margin 0.05 0.07

Short-term debt-paying ability:Current ratio 3.86 5.20

ClientClient IndustryIndustrySelected RatiosSelected Ratios


Summary of the Partsof Auditing Planning

A major purpose is to gain an understanding of the client’s business and industry.


Key Parts of PlanningPerform preliminary analytical procedures


Analytical Procedures

1. Required in the planning phase

2. Often done during the testing phase

3. Required during the completion phase

SAS 56 emphasizes the expectationsdeveloped by the auditor.


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

5. Expected results using nonfinancial data.


Compare Client and Industry Data

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

ClientClient IndustryIndustry

2007 2006 2007 2006


Compare Client Data with Similar Prior

Period Data

Net sales $143,086 100.0 $131,226 100.0Cost of goods sold 103,241 72.1 94,876 72.3Gross profit $ 39,845 27.9 $ 36,350 27.7Selling expense 14,810 10.3 12,899 9.8Administrative expense 17,665 12.4 16,757 12.8Other 1,689 1.2 2,035 1.6Earnings before taxes $ 5,681 4.0 $ 4,659 3.5Income taxes 1,747 1.2 1,465 1.1Net income $ 3,934 2.8 $ 3,194 2.4

20072007

(000)(000)Prelim.Prelim.

% of% ofNet salesNet sales

20062006

(000)(000)Prelim.Prelim.

% of% ofNet salesNet sales


Common Financial Ratios

Short-term debt-paying ability

Liquidity activity ratios

Ability to meet long-term debt obligations

Profitability ratios


Short-term Debt-paying Ability

Current ratioCurrent assets

Current liabilities=

Cash ratio(Cash + Marketable securities)

Current liabilities=

Quick ratio(Cash + Marketable securities

+ Net accounts receivable)Current liabilities

=


Liquidity Activity RatiosAccounts receivableturnover

Net salesAverage gross receivables

=

Days to collectreceivable

365 days365 daysAccounts receivable turnover

=

Inventoryturnover

Cost of goods soldCost of goods soldAverage inventory

=

Days to sellinventory

365 days365 daysInventory turnover

=


Ability to Meet Long-term Debt Obligation

Debt to equityTotal liabilities

Total equity=

Times interestearned

Operating incomeInterest expense

=


Profitability RatiosEarningsper share

Net incomeAverage common shares outstanding

=

Gross profitpercent

(Net sales – Cost of goods sold)Net sales

=

Profit marginOperating income

Net sales=


Profitability Ratios

Return oncommonequity

(Income before taxes– Preferred dividends)

Average stockholders’ equityAverage stockholders’ equity=

Return onassets

Income before taxesAverage total assets

=


Summary of Analytical Procedures

They involve the computation of ratiosand other comparisons of recordedamounts to auditor expectations.

They are used in planning to understandthe client’s business and industry.

They are used throughout the audit to identifypossible misstatements, reduce detailed tests,and to assess going-concern issues.


End of Chapter End of Chapter End of Chapter End of Chapter

Documents

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 8 - 1 Audit Planning and Analytical Procedures