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Chapter 9 Analytical Procedures and Ratios . Dr. Mohamed A. Hamada Lecturer of AIS. Learning Objective. State the purposes of analytical procedures and the timing of each purpose . Select the most appropriate analytical procedure from among the five major types.

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chapter 9 analytical procedures and ratios

Chapter 9Analytical Procedures and Ratios

Dr. Mohamed A. Hamada

Lecturer of AIS

learning objective
Learning Objective

State the purposes of analytical procedures and the timing of each purpose.

Select the most appropriate analytical procedure from among the five major types

analytical procedures may be performed at any of three times
Analytical procedures may be performed at any of three times
  • Analytical procedures are required in the planning phase to assist in determining the nature, extent, and timing of audit procedures
  • Analytical procedures are often done during the testing phase of the audit as a substantive test in support of account balances
  • Analytical procedures are also required during the completion phase of the audit
learning objective 7
Learning Objective 7

Select the most appropriate analytical procedure from among the five major types.

five types of analytical procedures
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
Compare Client and Industry Data

Client

Industry

2009

2008

2009

2008

Inventory turnover 3.4 3.5 3.9 3.4

Gross margin 26.3% 26.4% 27.3% 26.2%

compare client data with similar prior period data
Compare Client Data with Similar Prior Period Data

2009

2008

(000)

Prelim.

% of

Net sales

(000)

Prelim.

% of

Net sales

Net sales $143,086 100.0 $131,226 100.0

Cost of goods sold 103,241 72.1 94,876 72.3

Gross profit $ 39,845 27.9 $ 36,350 27.7

Selling expense 14,810 10.3 12,899 9.8

Administrative expense 17,665 12.4 16,757 12.8

Other 1,6891.22,0351.6

Earnings before taxes $ 5,681 4.0 $ 4,659 3.5

Income taxes 1,7471.2 1,4651.1

Net income $ 3,934 2.8 $ 3,194 2.4

example
Example
  • Suppose that the gross margin percentage between 26 and 27 percent for each of the past 4 years but has dropped to 23 percent in the current year.
  • This decline in gross margin should be a concern to the auditor if a decline is not expected.
  • The cause of the decline could be a change in economic conditions.
  • But, it could also be caused by misstatements in the financial statements, such as sales or purchase cutoff errors, unrecorded sales, overstated accounts payable, or inventory costing errors.
learning objective 8
Learning Objective 8

Compute common financial ratios.

common financial ratios
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

(Cash + Marketable securities*)

Current liabilities

(Cash + Marketable securities

+ Net accounts receivable)

Current liabilities

Short-term Debt-paying Ability

Cash ratio

=

Quick ratio

=

Current ratio

Current assets

Current liabilities

=

*(Stocks , Bonds , Treasury Securities)

liquidity activity ratios
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

Average inventory

Days to sell

inventory

=

365 days

Inventory turnover

*the average of the beginning and ending accounts receivable balances for the period

ability to meet long term debt obligation
Ability to Meet Long-term Debt Obligation

Debt to equity

=

Total liabilities

Total equity

Times interest

Earned*

=

Operating income

Interest expense

*how many times a company can cover its interest charges. Failing to meet these obligations could force a company into bankruptcy

profitability ratios
Profitability Ratios

Earnings

per share

=

Net income

Average common shares outstanding

Gross profit

percent

=

(Net sales – Cost of goods sold)

Net sales

Profit margin

Operating income

Net sales

=

profitability ratios1
Profitability Ratios

Return on

assets

=

Income before taxes

Average total assets

Return on

common

equity

=

(Income before taxes

– Preferred dividends)

Average stockholders’ equity

summary of analytical procedures
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 client’s business and industry.

They are used throughout the audit to identify

possible misstatements, reduce detailed tests,

and to assess going-concern issues.