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Audit Planning and Analytical Procedures. Chapter 8. First Standard of Fieldwork (GAAS). The work is to be adequately planned and assistants, if any, are to be properly supervised. To obtain sufficient competent evidence for the circumstances. 1. To help keep audit costs reasonable.

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Audit Planning and Analytical Procedures

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first standard of fieldwork gaas
First Standard of Fieldwork (GAAS)
  • The work is to be adequately planned
  • and assistants, if any, are to be
  • properly supervised.
three main reasons for planning

To obtain sufficient competent evidence

for the circumstances


To help keep audit costs reasonable


To avoid misunderstanding with the client


Three Main Reasons for Planning
managing risk is an important aspect of auditing
Managing Risk is an Important Aspect of Auditing

Acceptable audit risk – level of risk the auditor

will accept, that an unqualified opinion is

mistakenly issued.

Inherent risk – likelihood of material misstatements

In accounts before I/C effectiveness is considered.

planning an audit and designing an audit approach

Assess client business


Understand the client’s

business and industry.

Perform preliminary

analytical procedures.

Planning an Audit and Designing an Audit Approach

Accept client and

perform initial

audit planning.

planning an audit and designing an audit approach6

Gather information to

assess fraud risks.

Understand internal

control and assess

control risk.

Develop overall audit

plan and audit program.

Planning an Audit and Designing an Audit Approach

Set materiality and

assess acceptable audit

risk and inherent risk.

the engagement letter
The Engagement Letter
  • Not required by GAAS, but is very useful.
  • GAAS does require a clear understanding of the terms of the engagement between auditor and client.
understanding of the client s business and industry
Understanding of the Client’s Business and Industry

Understand client’s business and industry.

Industry and external environment

Business operations and processes

Management and governance

Objectives and strategies

Measurement and performance

industry and external environment
Industry and External Environment

What are some 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

3. Unique accounting requirements

business operations and processes
Business Operationsand Processes

Factors the auditor should understand:

– Major sources of revenue

– Key customers and suppliers

– Sources of financing

– Information about related parties

– Ability to obtain financing

management and governance
Management and Governance

Management establishes the strategies and

processes followed by the client’s business.

Governance includes the client’s organizational

structure, as well as the activities of the board

of directors and the audit committee.

Corporate charter and bylaws

Code of ethics

Meeting minutes

related party transactions
Related Party Transactions
  • It is important to identify related parties to the client.
    • GAAP requires disclosure of material related party transactions
    • SOX prohibits loans to any director or executive officer of the company.
      • Financial institution exceptions
code of ethics
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.

The SEC also requires companies to disclose

amendments and waivers to the code of ethics.

client objectives and strategies
Client Objectives and 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
measurement and performance
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

Performance measurement includes ratio analysis

and benchmarking against key competitors.

assess client business risk
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

statements due to client business risk

assess client business risk17
Assess Client Business Risk

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

committee of any significant deficiencies

in internal control.

the client s business risk and auditor s risk assessment

Assess client business


Assess risk of material


The Client’s Business, Risk, andAuditor’s Risk Assessment

Industry and external environment

Understand client’s

business and industry.

Business operations and processes

Management and governance

Objectives and strategies

Measurement and performance

enterprise risk management
Enterprise Risk Management

Enterprise risk management (ERM) has

emerged as a new paradigm for managing risk.

ERM integrates and coordinates risk

management across the entire enterprise.

preliminary analytical procedures
Preliminary Analytical Procedures

Comparison of client ratios to industry

or competitor benchmarks provides an

indication of the company’s performance.

Analytical procedures are also an important

part of testing throughout the audit.

examples of planning analytical procedures

Selected Ratios



Short-term debt-paying ability:

Current ratio 3.86 5.20

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

key parts of planning

New client

acceptance and


Obtain an


with client

Identify client’s

reasons for audit

Staff the


Key Parts of Planning

Accept client and perform

initial planning

key parts of planning23

Understand client’s

industry and external


Understand client’s

operations, strategies,

and performance


Key Parts of Planning

Understand the client’s

business and industry

key parts of planning24

Assess client

business risk

Assess risk

of material


Evaluate management controls

affecting business risk

Key Parts of Planning

Assess client business risk

key parts of planning25
Key Parts of Planning

Perform preliminary analytical procedures

analytical procedures
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.

five types of analytical procedures
Five Types of Analytical 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.

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%

Compare Client and Industry Data
compare client data with similar prior period data





% of

Net sales



% 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 1,689 1.2 2,035 1.6

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

Income taxes 1,747 1.2 1,465 1.1

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

Compare Client Data with Similar Prior Period Data
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
Short-term Debt-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

liquidity activity ratios
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

Days to sell inventory:

365 days ÷ Inventory turnover

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

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 ratios36
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.