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©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 8 - 1 Audit Planning and Analytical Procedures.

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Presentation on theme: "©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 8 - 1 Audit Planning and Analytical Procedures."— Presentation transcript:

1 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Audit Planning and Analytical Procedures

2 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Acceptance of Clients Juan M. Garcia Merced

3 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder First Standard of Field Work The work is to be adequately planned, and assistants, if any, are to be properly supervised.

4 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Obtaining Clients Through: Acquisitions Business contacts Social contacts Advertising

5 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Auditor’s Business Risk A thoroughly investigation of prospective clients should be made.

6 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Submitting a Proposal Should include: Nature of services Qualifications Fees & other information Audit committee

7 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Communication with Predecessor Auditor The successor auditor must ask management to authorize the predecessor to respond fully. Key issue in deciding whether to accept the engagement.

8 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Auditor inquiries will include: Disagreements with management over accounting principles or scope limitations The predecessor’s understanding for the change in auditors The integrity of management Communications with audit committees regarding important audit issues

9 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Items Included in Engagement Letters Name of the entity Management responsibilities –Financial statements –Establishing effective internal control over financial reporting –Compliance with laws and regulations –Making records available to the auditors –Providing written representations at end of the audit, including that adjustments discovered by the auditors and not recorded to the financials are not material Auditor responsibilities –Conducting an audit in accordance with GAAS –Obtaining an understanding of internal control to plan audit and to determine the nature, timing and extent of procedures –Making communications required by GAAS

10 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Engagement Letters--Optional Items Arrangements regarding –Conduct of the audit (e.g., timing, client assistance) –Use of specialists or internal auditors –Obtaining information from predecessor auditors –Fees and billing Other services to be provided, such as examination of internal control over financial reporting Limitation of or other arrangements regarding liability of auditors or client Conditions under which access to the auditors’ working papers may be granted to others

11 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder ENGAGEMENT LETTER Required!!!!!!!!!!!!!!!

12 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Generally Accepted Auditing Standards General –Technical training and efficiency –Independence –Due professional care Field Work –Planning and supervision –Internal control –Evidence Reporting –GAAP –Disclosure –Opinion –Consistency

13 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Audit Planning Gain an understanding of the client’s business and industry.

14 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Business Operations and Processes Factors the auditor should understand:  Major sources of revenue  Key customers and suppliers  Sources of financing  Information about related parties

15 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Tour the Plant and Offices By viewing the physical facilities, the auditor can asses physical safeguards over assets and interpret accounting data related to assets.

16 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 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  Meeting minutes  Code of ethics

17 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 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.

18 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 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

19 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Perform preliminary analytical procedures.

20 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Preliminary Analytical Procedures Comparison of client ratios to industry or competitor benchmarks provides an indication of the company’s performance. Preliminary tests can reveal unusual changes in ratios.

21 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Examples of Planning Analytical Procedures Liquidity activity ratio: Inventory turnover Ability to meet long-term obligations: Debt to equity Profitability ratio: Profit margin Short-term debt-paying ability: Current ratio ClientIndustry Selected Ratios

22 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Summary of the Parts of Auditing Planning A major purpose is to gain an understanding of the client’s business and industry.

23 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Key Parts of Planning Perform preliminary analytical procedures

24 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Analytical Procedures 1.Required in the planning phase 2.Often done during the testing phase 3.Required during the completion phase SAS 56 emphasizes the expectations developed by the auditor.

25 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 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.

26 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Compare Client and Industry Data Inventory turnover Gross margin26.3%26.4%27.3%26.2% ClientIndustry

27 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Compare Client Data with Similar Prior Period Data Net sales$143, $131, Cost of goods sold 103, , Gross profit$ 39, $ 36, Selling expense 14, , Administrative expense 17, , Other 1, , Earnings before taxes$ 5, $ 4, Income taxes 1, , Net income$ 3, $ 3, (000)Prelim. % of Net sales 2006 (000)Prelim. % of Net sales

28 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Common Financial Ratios  Short-term debt-paying ability  Liquidity activity ratios  Ability to meet long-term debt obligations  Profitability ratios

29 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Short-term Debt-paying Ability Current ratio Current assets Current liabilities = Cash ratio (Cash + Marketable securities) Current liabilities = Quick ratio (Cash + Marketable securities + Net accounts receivable) Current liabilities =

30 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 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 =

31 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Ability to Meet Long- term Debt Obligation Debt to equity Total liabilities Total equity = Times interest earned Operating income Interest expense =

32 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 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 =

33 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Profitability Ratios Return on common equity (Income before taxes – Preferred dividends) Average stockholders’ equity = Return on assets Income before taxes Average total assets =

34 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 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.

35 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder End of Chapter


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