©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 1
Audit Planning andAnalytical 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
3. To avoid misunderstanding with the client
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Three Main Reasons for Planning
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Risk Terms
Acceptable audit risk
Inherent 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
4. Develop overall audit strategy
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Client Acceptance and Continuance
New client investigations If previously audited, the new auditor is required to communicate with the predecessor auditor
Client permission required
Continuing clientsAnnual evaluations whether to continue based on issues, fees, and client integrity
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Identify Reasons for the Audit
Two major factors affecting acceptable risk Likely statement users Intended uses of the statements
Likely to accumulate more evidence for companies that are
Publicly held Have extreme indebtednessLikely to be sold
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Obtaining an Understanding with the Client
Engagement terms should be understood between CPA and client.Standards require an engagement letter describing:objectives responsibilities of auditor and managementschedules and fees
Informs client that auditor cannot guarantee all acts of fraud will be discoveredSee figure 8-2
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Develop Overall Audit Strategy
Preliminary audit strategy should consider client’s business and industrymaterial misstatement risk areasnumber of client locations past effectiveness of controls
Preliminary strategy helps auditor determine resource requirements and staffingstaff continuityneed for specialists
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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
IndustryClient business risk is the risk that the client will fail to meet its objectives.
Information technology
Global operations
Human capital
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Understanding of the Client’s Business and
Industry
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Industry and External Environment
Reasons for obtaining an understanding of theclient’s industry and external environment:
1. Risks associated with specific industries2. Inherent risks common to all clients in
certain industries3. Unique accounting requirements
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Business Operationsand Processes
Factors the auditor should understand:
Major sources of revenue Key customers and suppliers Sources of financing Information about related parties
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Tour the Plant and Offices
Touring the physical facilities enables the auditor to assess asset safeguards and interpretaccounting data related to assets.
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Identify Related Parties
Affiliated companies
Principal owners of the client
Any other party with which the client deals
A party who can influence management or client policies
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Management and Governance
Management establishes the strategies andprocesses followed by the client’s business.
Governance includes:Organizational structure
Board activities Audit committee activities.
Governance insights:Corporate charter and bylawsCode of ethicsMeeting minutes
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Code of Ethics
In response to the Sarbanes-Oxley Act, the SECnow requires each public company to disclosewhether is has adopted a code of ethics thatapplies to senior management.
The SEC also requires companies to discloseamendments and waivers to the code of ethics.
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Client Objectives and Strategies
Strategies are approaches followed by theentity 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 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.
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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 theclient will fail to achieve its objectives.
What is the auditor’s primary concern? Material misstatements in the financial
statements due to client business risk
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Client’s Business, Risk, andRisk of Material Misstatement
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Sarbanes-Oxley Act
Management must certify it has designeddisclosure controls and procedures toensure that material information aboutbusiness risks is made known to them.
Management must certify it has informed the auditor and audit committee of any significant control deficiencies.
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Learning Objective 5
Perform preliminary analytical procedures.
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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.
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Examples of Planning Analytical Procedures
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Summary of the Partsof Auditing Planning
A major purpose is to gain an understanding of the client’s business and industry.
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Planning an Audit and Designing an Audit
ApproachSet materiality and assess acceptable audit risk and inherent risk.
Understand internal control and assess control risk
Gather information to assess fraud risks
Develop overall audit plan and audit program
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Learning Objective 6
State the purposes of analytical procedures and the timing of each procedure.
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Analytical Procedures
1. Required in the planning phase2. Often done during the testing phase3. Required during the completion phase
AU 329 emphasizes the expectationsdeveloped by the auditor.
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Timing and Purposes of Analytical Procedures
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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 data2. Similar prior-period data3. Client-determined expected results4. Auditor-determined expected results5. Expected results using nonfinancial data.
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Compare Client and Industry Data
Inventory turnover 3.4 3.5 3.9 3.4Gross margin 26.3% 26.4% 27.3% 26.2%
Client Industry2009 2008 2009 2008
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Internal Comparisons
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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
2009(000)
Prelim.% of
Net sales
2008(000)
Prelim.% of
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
Ability to meet long-term debt obligations
Profitability ratios
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Short-term Debt-paying Ability
Current ratio Current assetsCurrent liabilities=
Cash ratio (Cash + Marketable securities)Current liabilities=
Quick ratio(Cash + Marketable securities
+ Net accounts receivable)Current liabilities
=
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Liquidity Activity RatiosAccounts receivable
turnoverNet sales
Average gross receivables=
Days to collectreceivable
365 daysAccounts receivable turnover=
Inventoryturnover
Cost of goods soldAverage inventory=
Days to sellinventory
365 daysInventory turnover=
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Ability to Meet Long-term Debt Obligation
Debt to equity Total liabilitiesTotal equity=
Times interestearned
Operating incomeInterest expense=
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Profitability RatiosEarningsper share
Net incomeAverage common shares outstanding=
Gross profitpercent
(Net sales – Cost of goods sold)Net sales=
Profit margin
Operating incomeNet sales=
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Profitability Ratios
Return oncommonequity
(Income before taxes– Preferred dividends)
Average stockholders’ equity=
Return onassets
Income before taxesAverage total assets=
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Summary of Analytical Procedures
Compare ratios of recorded amounts to auditor expectations.
Used in planning to understand client’s business and industry.
Used throughout the audit to identify possible misstatementsreduce detailed testsassess going-concern issues.
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End of Chapter 8