Chapter 1 - The Demand for Audit and Other Assurance Services

Chapter 1 - The Demand for Audit and Other Assurance Services

Audit Planning and Analytical Procedures Chapter 8 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-1 Learning Objective 1 Discuss why adequate audit planning is essential. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

8-2 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-3 Three Main Reasons for

Planning 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-4 Risk Terms Acceptable audit risk Inherent risk 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-5

Learning Objective 2 Make client acceptance decisions and perform initial audit planning. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-6 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

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-7 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-8 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 indebtedness

Likely to be sold 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-9 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 managemen

schedules and fees Informs client that auditor cannot guarantee all acts of fraud will be discovered See figure 8-2 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 10 Develop Overall Audit Strategy Preliminary audit strategy should consider clients business and industry material misstatement risk areas

number of client locations past effectiveness of controls Preliminary strategy helps auditor determin resource requirements and staffing staff continuity need for specialists 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 11 Learning Objective 3 Gain an understanding of the clients business and industry.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 12 Understanding of the Clients Business and Industry Client business risk is the risk that the client will fail to meet its objectives. Information technology Global operations Human capital 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

8 - 13 Understanding of the Clients Business and Industry 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 14 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 15 Business Operations and Processes Factors the auditor should understand:

Major sources of revenue Key customers and suppliers Sources of financing Information about related parties 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 16 Tour the Plant and Offices

Touring the physical facilities enables the auditor to assess asset safeguards and interpret accounting data related to assets. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 17 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 18 Management and Governance Governance includes: Organizational structure Board activities Audit committee activities.

Governance insights: Corporate charter and bylaws Code of ethics Meeting minutes Management establishes the strategies and processes followed by the clients business. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 19 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. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 20 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 21 Measurement and Performance The clients 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 analys and benchmarking against key competitors. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 22

Learning Objective 4 Assess client business risk. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 23 Assess Client Business Risk Client business risk is the risk that the client will fail to achieve its objectives. What is the auditors primary concern? Material misstatements in the financial statements due to client business risk

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 24 Clients Business, Risk, and Risk of Material Misstatement 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 25 Sarbanes-Oxley Act

Management must certify it has designed disclosure controls and procedures to ensure that material information about business risks is made known to them. Management must certify it has informed the auditor and audit committee of any significant control deficiencies. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 26 Learning Objective 5 Perform preliminary analytical procedures.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 27 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. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

8 - 28 Examples of Planning Analytical Procedures 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 29 Summary of the Parts of Auditing Planning A major purpose is to gain an understanding of the clients business and industry.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 30 Planning an Audit and Designing an Audit Approach Set 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 31 Learning Objective 6 State the purposes of analytical procedures and the timing of each procedure. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 32

Analytical Procedures AU 329 emphasizes the expectations developed by the auditor. 1. Required in the planning phase 2. Often done during the testing phase 3. Required during the completion phase 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 33 Timing and Purposes of Analytical Procedures

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 34 Learning Objective 7 Select the most appropriate analytical procedure from among the five major types. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 35 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.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 36 Compare Client and Industry Data Client 2009 2008 Industry 2009

2008 Inventory turnover 3.4 3.5 3.9 3.4 Gross margin 26.3% 26.4% 27.3% 26.2% 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 37

Internal Comparisons 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 38 Compare Client Data with Similar Prior Period Data 2009 (000) % of Prelim. Net sales Net sales Cost of goods sold

Gross profit Selling expense Administrative expense Other Earnings before taxes Income taxes Net income 2008 (000) % of Prelim.Net sales

$143,086 100.0 $131,226 100.0 103,241 72.1 94,876 72.3 $ 39,845 27.9 $ 36,350 27.7 14,810 10.3 12,899 9.8 17,665 12.4 16,757 12.8 1,689 1.2 2,035

1.6 $ 5,681 4.0 $ 4,659 3.5 1,747 1.2 1,465 1.1 $ 3,934 2.8 $ 3,194 2.4

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 39 Learning Objective 8 Compute common financial ratios. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 40 Common Financial Ratios Short-term debt-paying ability Liquidity activity ratios

Ability to meet long-term debt obligations Profitability ratios 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 41 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 42 Liquidity Activity Ratios Accounts receivable Net sales = turnover Average gross receivables

Days to collect receivable 365 days = Accounts receivable turnov Inventory turnover Cost of goods sold = Average inventory

Days to sell inventory 365 days = Inventory turnover 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 43 Ability to Meet Long-term Debt Obligation Total liabilities

Debt to equity= Total equity Times interest Operating income = earned Interest expense 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 44 Profitability Ratios Earnings =

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

Net sales 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 45 Profitability Ratios Return on = assets Income before taxes Average total assets

Return on common = equity (Income before taxes Preferred dividends) Average stockholders equity 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 46 Summary of Analytical Procedures

Compare ratios of recorded amounts to auditor expectations. Used in planning to understand clients business and industry. Used throughout the audit to identify possible misstatements reduce detailed tests assess going-concern issues. 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 47 End of Chapter 8

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8 - 48

Recently Viewed Presentations

  • Hebrew Poetry - BibleTalk.tv

    Hebrew Poetry - BibleTalk.tv

    Characteristics of Hebrew Poetry . Emblematic - comparisons (like or as) - Ps. 103:12-13. As far as the east is from the west, So far has He removed our transgressions from us. Just as a father has compassion on his...
  • MMI HLDA - University of Colorado Boulder

    MMI HLDA - University of Colorado Boulder

    And, a few annotation Errors Some Interesting Problems Addressed Word sense annotation transferred from old Treebank to new Treebank Coreference annotation transferred to new Treebank Treebank/PropBank with or without NMLs reside in harmony Various levels of data quality identified in...
  • Ocean Pollution - WordPress.com

    Ocean Pollution - WordPress.com

    There's also the problem of the oil that goes down with the ship, which can contaminate the seabed and marine organisms. This oil can also resurface. In 2001, a cyclone off the island of Yap in Micronesia disturbed the oil...
  • On Efficiet, Secure and Reliable Management of Software ...

    On Efficiet, Secure and Reliable Management of Software ...

    SDNShield: ReconciliatingConfigurable Application Permissions for SDN App Markets. Yan Chen. Lab of Internet and Security Technology (LIST) Northwestern University, USA. Joint work with Xitao Wen, Bo Yang Chengchen Hu, Yi Wang, Bin Liu, and Xiaolin Chen
  • The Atlantic World 1492 - 1800

    The Atlantic World 1492 - 1800

    The Voyages of Columbus. First Encounters. Convinced that he had a way to reach China, Columbus tried to find backers for a voyage, but did not succeed until Queen Isabella of Spain agreed to fund his voyage west across the...
  • Plants - LBHS Biology

    Plants - LBHS Biology

    Plants Nonvascular Plants Hornwort Usually small plants Everything transported by diffusion and osmosis Life Cycle of Nonvascular Plants Vascular Plants (Seedless) Some early vascular plants only reproduce with spores and not seeds Ferns are examples of these Spores (how a...
  • EDRN Informatics EDRN Informatics Center Infrastructure Capabilities and

    EDRN Informatics EDRN Informatics Center Infrastructure Capabilities and

    eCAS. BioMuta. LabCAS. What's in Place Today. ... Portal: Dissemination and Access to Biomarker Data. Gateway to information. Information managed both within and outside the knowledge system. Initial starting point for community to get to research data.
  • POSTURE AND BALANCE POSTURAL MECHANISMS Motor Control Feedforward

    POSTURE AND BALANCE POSTURAL MECHANISMS Motor Control Feedforward

    POSTURE AND BALANCE Motor Control Limb Movement Postural Disturbance Postural Adjustment Feedforward Commands (planned, learned) Feedback Commands (learned and reflexive) POSTURAL MECHANISMS Cutaneous and Proprioceptive Visual Vestibular SIGNALS OF POSTURAL DISTURBANCE S L I M VPL, Post. N. FEEDFORWARD CONTROLS...