AUDIT PLANNING AND

ANALYTICAL PROCEDURES
CHAPTER 8

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

8-1

TOPIC OUTLINES
Client acceptance and perform initial audit
planning
Understand the clients business and
industry
Assess client business risk
Perform preliminary analytical procedure
Summary of purposes of audit planning

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RISK TERMS

Acceptable audit risk

Inherent risk
Business risk

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8-3

INITIAL AUDIT PLANNING

1. Client acceptance and continuance
2. Identify clients 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 clients
Annual evaluations whether to continue
based on issues, fees, and client integrity
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8-5

IDENTIFY REASONS FOR THE AUDIT

Two major factors affecting acceptable risk
Users of financial statements
Intended uses of financial statements
Likely to accumulate more evidence for
companies that are :
Public listed companies
Have extreme indebtedness
Likely to be sold
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8-6

OBTAINING AN UNDERSTANDING WITH THE CLIENT

Engagement terms should be understood between
audit firm and client.

Auditing standards require an engagement letter

describing:
objectives
responsibilities of auditor and management
schedules and fees
Informs client that auditor cannot guarantee
all acts of fraud will be discovered
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8-7

DEVELOP OVERALL AUDIT STRATEGY

Preliminary strategy helps auditor determine

resource requirements and staffing
staff continuity
need for specialists (ISA620)

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INDUSTRY AND EXTERNAL ENVIRONMENT

Reasons for obtaining an understanding of the
clients industry and external environment:
1. Risks associated with specific industries
2. Inherent risks common to all clients in
certain industries
3. Unique accounting requirements

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BUSINESS OPERATION & PROCESSES TOUR THE

PLANT AND OFFICES

Touring the physical facilities enables

the auditor to assess asset safeguards
and interpret accounting data related
to assets.

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BUSINESS OPERATION & PROCESSES IDENTIFY

RELATED PARTIES (FRS124)

Any transaction between the client and a

related party.
Example: sales and purchase transaction
between parent company and its subsidiary.

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MANAGEMENT AND GOVERNANCE

Governance includes:
Organizational
Governance insights:
structure
MOA & AOA
Board activities
Minutes of meeting
Audit committee
activities.

Management establishes the strategies and

processes followed by the clients business.
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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
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MEASUREMENT AND PERFORMANCE

The clients performance measurement system

includes key performance indicators. Examples:
market share
sales per employee
unit sales growth

Performance measurement includes ratio analys

and benchmarking against key competitors.
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UNDERSTANDING OF THE CLIENTS BUSINESS AND

INDUSTRY

Client business risk is the risk that the client

will fail to meet its objectives.
What is the auditors primary concern?
Material misstatements in the financial
statements due to client business risk
Figure 8-4; pg. 200 (2nd)
Figure 8-4; pg. 208 (3rd)

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PRELIMINARY ANALYTICAL PROCEDURES

Comparison of client ratios to industry

or competitor benchmarks provides an
indication of the companys performance.
Preliminary tests can reveal unusual
changes in ratios.

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ANALYTICAL PROCEDURES
ISA 520 analysis of significant ratios and
trends
1. Required in the planning phase
2. Often done during the testing phase
3. Required during the completion phase

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FIVE TYPES OF ANALYTICAL PROCEDURES

Compare client data with:
1.
2.
3.
4.
5.

Industry data
Similar prior-period data
Client-determined expected results
Auditor-determined expected results
Expected results using nonfinancial data.

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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

(Cash + Marketable securities)
Cash ratio =
Current liabilities
(Cash + Marketable securities
Quick ratio = + Net accounts receivable)
Current liabilities
Current assets
Current ratio =
Current liabilities
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LIQUIDITY ACTIVITY RATIOS

Accounts receivable
Net sales
=
turnover
Average gross receivables
Days to collect
receivable

365 days
=
Accounts receivable turnove

Inventory
turnover

Cost of goods sold

=
Average inventory

Days to sell
inventory

365 days
=
Inventory turnover

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ABILITY TO MEET LONG-TERM DEBT OBLIGATION

Total liabilities
Debt to equity =
Total equity
Times interest Operating income
=
earned
Interest expense

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PROFITABILITY RATIOS

Earnings
Net income
=
per share
Average common shares outstanding
Gross profit
(Net sales Cost of goods sold)
=
percent
Net sales
Profit
margin

Operating income
=
Net sales

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PROFITABILITY RATIOS
Return on
Income before taxes
=
assets
Average total assets
Return on
(Income before taxes
common =
Preferred dividends)
equity
Average stockholders equity

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SUMMARY OF ANALYTICAL PROCEDURES

1. Comparison analysis (slides #18)

2. Compare ratios of recorded amounts to auditor
expectations.
3. Identify any unusual transactions during the period.

1. Used in planning to understand clients business and industry.

2. Used throughout the audit
to identify possible misstatements
reduce detailed tests
assess going-concern issues.

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TUTORIAL WEEK 9
Review questions:
8-4; 8-5; 8-11, 8.14, 8.20
Discussion questions:
8.34 (a) pg. 226
Announcement on submission of Assignment 2
Week 11 (13, 14 or 15 December 2016).
Please submit according to your class schedule.

THANK YOU
You can never cross the ocean until you have the courage to lose
sight of the shore. Christopher Columbus

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