Post on 01-Jan-2016
Chapter 8Audit Planning and Analytical
Procedures
J. Smith, CPAAudit Plan
Presentation Outline
I. Accept Client and Perform Initial Audit PlanningII. Understand the Client’s Business and Industry
III. Assess Client Business RiskIV. Perform Preliminary Analytical Procedures
I. Accept Client and Perform Initial Planning
A. Client Acceptance and Continuance
B. Identify Client’s Reasons for Audit
C. Obtain an Understanding with the Client
D. Select Staff for the Engagement
E. Evaluate Need for Outside Specialist
Acceptable Audit Risk - how willing the auditor is to accept that the financial statements may be materially misstated when an unqualified opinion is issued.
A. Client Continuance and Acceptance
Association with client’s who lack integrity can cause significant
problems.SAS 84 requires a successor
auditor to communicate with the predecessor auditor. Predecessor must obtain permission from client before responding. Response may
be limited.Lawsuits between the CPA and
client or unpaid fees for services performed more than 1 year
previously, will prohibit acceptance of the audit client.
B. Identify Client’s Reasons for Audit
Two major factors affecting acceptable audit risk are
likely statement users and their intended uses of the statements. More
evidence may be necessary when the statements are to be
used extensively.
The most likely uses can be determined from previous experience with the client
and discussion with management.
C. Obtaining an Understanding with the Client
SAS 83 requires auditors to document their understanding of the engagement in the audit files.
Although not required, an engagement letter is normally
used to establish the agreement.Auditors of public companies
should establish the understanding with the audit
committee.
Contents of Engagement Letter Services to be provided
Any restrictions on the auditors’ work
Deadlines for completing the work Assistance to be provided by
client personnel Inform client that fraud may not be
discovered May include fees
D. Select Staff for the Engagement
Staff should be knowledgeable of the client’s industry.
Continuity of staff helps the CPA firm maintain familiarity with technical requirements.
E. Evaluate Need for Outside Specialists
If an audit client requires specialized knowledge, it may
be necessary to consult a specialist.
Auditor should evaluate the specialist’s qualifications and understand the objectives and
scope of their work. Auditor should also consider
specialist’s relationship to client that could impair
objectivity.
II. Understand the Client’s Business and Industry
A. Major Reasons for Understanding Client Industry and External Environment
B. Business Operations and Processes C. Management and Governance
D. Client Objectives and StrategiesE. Measurement and Performance
The nature of the client’s business and industry affects client business risk and the risk of material misstatements in the financial
statements.
A. Major Reasons for UnderstandingClient Industry and External Environment
1. There may be risks associated with the client and the specific industry in which
it operates.2. Many industries have unique
accounting requirements that the auditor must understand.
B. Business Operations and Processes
Tour the plant and offices to better understand client operations and meet key personnel.
Identify related parties for purposes of disclosure. Related parties include an affiliated company, a
principal owner of client, and others who can influence the management or operating policies of the other.
Sarbanes-Oxley prohibits personal loans to client executives, except for normal loans by banks using
market rates.
C. Management and Governance
Management philosophy and operating style significantly influence the risk of material misstatement in the financial
statements. Sarbanes-Oxley requires public
companies to disclose whether they have adopted a code of
ethics for senior management. If not, they must state why.
Corporate minutes should be read by the auditor to identify
various authorizations that must be complied with.
D. Client Objectives and Strategies
Strategies are approaches followed by the entity to achieve organizational
objectives. Auditor should understand client strategies
regarding:Reliability of financial
reportingEffectiveness and efficiency of
operationsCompliance with laws and
regulations
E. Measurement and Performance
The risk of financial misstatements may be
increased if the client has set unreasonable objectives or if the
performance measurement system
encourages aggressive accounting.
III. Assess Client Business RiskClient business risk is the risk that the client will fail to achieve its
objectives. Sources include competitors, new technology, industry condition, and regulatory environment. Could influence client to
misstate the financial statements.Sarbanes-Oxley requires management to certify it has designed disclosure controls and procedures to ensure that they are made
aware of material information about business risks. Sarbanes-Oxley also requires management to certify that it has
informed the auditor and audit committee of any significant deficiencies in internal control.
IV. Perform Preliminary Analytical Procedures
A. Defining Analytical Procedures
B. Short-term Debt-Paying Ability
C. Liquidity Activity Ratios
D. Ability to Meet Long-term Debt Obligation
E. Profitability Ratios
A. Defining Analytical Procedures
Evaluations of financial information made by a study of plausible relationships among financial and non-financial data.
See purpose of procedures during audit phases in Figure 8-6 on page 209.
B. Short-term Debt-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
C. 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
C. Liquidity Activity Ratios (Continued)
Days to sell inventory:365 days ÷ inventory turnover
D. Ability to Meet Long-term Debt Obligation
Debt to equity:Total liabilities ÷ Total equity
Times interest earned:Operating income ÷ Interest expense
E. Profitability Ratios
Earnings per share:Net income ÷ Average commons shares outstanding
Gross profit percent:(Net sales – Cost of goods sold) ÷ Net sales
Profit margin:Operating income ÷ Net sales
E. Profitability Ratios (Continued)
Return on assets:Income before taxes ÷ Average total assets
Return on common equity:(Income before taxes – Preferred dividends)
÷ Average stockholders’ equity
Initial Audit Planning
Accept client andperform initial audit
planning
Understand the client’sbusiness and industry
Assess client business risk
Perform preliminary analytical procedures