7 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit Planning and Analytical Procedures Chapter 7.

7 - 1©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley

Audit Planning andAnalytical Procedures

Chapter 7


Learning Objective 1

Discuss why adequate audit

planning is essential.


Planning

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

Acceptable audit risk

Inherent risk


Planning an Audit andDesigning an Approach

Accept client andperform initialaudit planning

Understand theclient’s business

and industry

Assess clientbusiness risk

Perform preliminaryanalytical procedures


Planning an Audit andDesigning an Approach

Set materiality, andassess acceptable auditrisk and inherent risk

Develop overallaudit plan andaudit program

Understand internalcontrol and assess

control risk



Make client acceptance

decisions and perform

initial audit planning.


Initial Audit Planning

Client acceptance and continuation

Identify client’s reasons for audit.

Obtain an understanding with the client.

Select staff for the engagement.



Gain an understanding of the

client’s business and industry.


Understanding of the Client’s Business and Industry

What are some factors that have increasedthe importance of understanding the

client’s business and industry?

Globaloperations

Informationtechnology

Humancapital


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

What are some reasons for obtaining an understanding of the client’s industry

and external environment?

Risks associated with specific industries

Inherent risks common to all clients in certain industries

Unique accounting requirements


Business Operationsand Processes

Factors the auditor should understand:

– major sources of revenue

– sources of revenue

– key customers and suppliers

– sources of financing

– information about related parties

– ability to obtain financing



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

Governance includes the client’s organizationalstructure, as well as the activities of the board

of directors and the audit committee.

Corporate charter and bylaws

Minutes of meetings


Client Objectivesand Strategies

Strategies are approaches followed by theentity to achieve organizational objectives.

Auditors should understand client objectives.

Effectivenessand efficiencyof operations

Financialreportingreliability

Compliancewith laws and

regulations



The client’s performance measurement systemincludes key performance indicators. Examples:

Performance measurement includes ratio analysisand benchmarking against key competitors.

– market share – sales per employee

– unit sales growth – Web site visitors

– same-store sales – sales/square foot



Assess client business risk.


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 misstatement of the financialstatements due to client business risk


The Client’s Business, Risk, and

Auditor’s Risk AssessmentIndustry and External Environment

Business Operations and Processes


Objectives and Strategies


Understand Client’sBusiness and Industry

Assess ClientBusiness Risk

Assess Risk ofMaterial Misstatements



Perform preliminary

analytical procedures.


Preliminary Analytical Procedures

Comparison of client ratios to industryor competitor benchmarks provides an

indication of the company’s performance.

Analytical procedures are also an importantpart of testing throughout the audit.


Examples of PlanningAnalytical Procedures

Liquidity Activity RatioInventory turnover 3.46 5.20

Ability to Meet Long-Term ObligationsDebt to equity 1.73 2.51

ProfitabilityReturn on assets 0.09 0.09

Client IndustryShort-Term Debt-Paying AbilityCurrent ratio 3.86 5.20

Selected Ratios


Key Parts of Planning

Accept Client and PerformInitial Planning

New clientacceptance and

continuance

Obtain anunderstanding

with client

Identify client’sreasons forthe audit

Staff theengagement



Understand the Client’sBusiness and Industry

Understandclient’s industry

and externalenvironment

Understandclient’s operations,

strategies, andperformance system



Assess ClientBusiness Risk

Evaluate managementbusiness controls

affecting business risk

Assess clientbusiness risk

Assess riskof material

misstatements



Perform PreliminaryAnalytical Procedures


Summary of the Purposesof Auditing Planning

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



State the purposes of analytical

procedures and the timing

of each purpose.


Analytical Procedures

Analytical procedures use comparisons andrelationships to assess whether account

balances or other data appear reasonable.

SAS 56 emphasizes the expectationsdeveloped by the auditor.


Timing and Purpose ofAnalytical Procedures

(Required)Planning Phase

Purpose

Understand client’sindustry and business

Primary purpose

Assess going concern Secondary purpose

Indicate possible misstatements(attention directing)

Primary purpose

Reduce detailed tests Secondary purpose



TestingPhase

Purpose


Assess going concern


Secondary purpose

Reduce detailed tests Primary purpose



(Required)Completion Phase

Purpose


Assess going concern Secondary purpose


Primary purpose

Reduce detailed tests



Select the most appropriate

analytical procedure from

among the five major types.


Five Major Types ofAnalytical 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 Clientand Industry Data

Client Industry2002 2001 2002 2001

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


Compare Client Data WithSimilar Prior-period Data

2002 2001 (000,000) % of (000,000) % of

Preliminary Net Sales Audited Net SalesNet sales 143 100 131 100Cost of goods sold 103 72 95 72Gross profit 40 28 36 28S & A 32 22 30 23Other 4 3 3 3Net income 4 3 3 2



Compute common

financial ratios.


Common Financial Ratios

Short-term debt-paying ability

Liquidity activity ratios

Ability to meet long-term debt obligations

Profitability ratios


Short-termDebt-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

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


Liquidity Activity Ratios

Days to sell inventory:365 days ÷ inventory turnover


Ability to Meet Long-termDebt Obligation

Debt to equity:Total liabilities ÷ Total equity

Times interest earned:Operating income ÷ Interest expense


Summary of Analytical Procedures

They involve the computation of ratiosand 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 identifypossible misstatements, reduce detailed tests,

and to assess going-concern issues.


End of Chapter 7

7 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit Planning and Analytical Procedures Chapter 7.

Documents

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essentials of auditing

client business risk

arenselderbeasley industry

clients industry

industry industry

financing slide

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