Transcript Chapter 8 Audit Planning and Analytical Procedures J. Smith, CPA Audit Plan Presentation Outline I. II. Accept Client and Perform Initial Audit Planning Understand the Client’s Business and.

Chapter 8
Audit Planning and Analytical
Procedures
J. Smith, CPA
Audit Plan
Presentation Outline
I.
II.
Accept Client and Perform Initial Audit Planning
Understand the Client’s Business and Industry
III. Assess Client Business Risk
IV. 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
Contents of Engagement Letter
SAS 83 requires auditors to
 Services to be provided
document their understanding of
the engagement in the audit files.  Any restrictions on the auditors’
work
Although not required, an
engagement letter is normally  Deadlines for completing the work
used to establish the agreement.  Assistance to be provided by
client personnel
Auditors of public companies
should establish the
 Inform client that fraud may not be
understanding with the audit
discovered
committee.
 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
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 Understanding Client Industry and
External Environment
B. Business Operations and Processes
C. Management and Governance
D. Client Objectives and Strategies
E. Measurement and Performance
A.
Major Reasons for Understanding
Client 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
reporting
Effectiveness and efficiency of
operations
Compliance 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 Risk
Client 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 nonfinancial 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 and
perform initial audit
planning
Understand the client’s
business and industry
Assess client business risk
Perform preliminary
analytical procedures