Audit Planning and

Analytical Procedures

Chapter 8

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 Learning Objective 1

Discuss why adequate audit

planning is essential.

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 Planning

The work is to be adequately planned, and

assistants, if any, are to be properly supervised.

Acceptable audit risk

Inherent risk

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 Planning an Audit and
Designing an Approach

Accept client and

Assess client
perform initial
business risk
audit planning

Understand the
Perform preliminary
clients business
analytical procedures
and industry

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 Planning an Audit and
Designing an Approach

Set materiality, and

assess acceptable audit
risk and inherent risk

Understand internal Develop overall

control and assess audit plan and
control risk audit program

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 Learning Objective 2

Make client acceptance

decisions and perform
initial audit planning.

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 Initial Audit Planning

Should the auditor accept a new client?

Identify why the client wants or needs an audit.
Obtain an understanding with the client.
Select staff for the engagement.

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 Learning Objective 3

Gain an understanding of the

clients business and industry.

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 Understanding of the Clients
Business and Industry
Understand Clients Business and Industry
Industry and External Environment
Business Operations and Processes
Management and Governance
Objectives and Strategies
Measurement and Performance
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 Understanding of the Clients
Business and Industry

What are some factors that have increased

the importance of understanding the
clients business and industry?

Information Global Human

technology operations capital

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 Industry and External
Environment
What are some reasons for obtaining an
understanding of the clients industry
and external environment?
Risks associated with specific industries
Inherent risks common to all
clients in certain industries
Unique accounting requirements

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 Business Operations
and Processes
Factors the auditor should understand:
major sources of revenue
sources of revenue
key customers and suppliers
sources of financing
information about related parties
ability to obtain financing
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 Management and Governance

Management establishes the strategies and

processes followed by the clients business.
Governance includes the clients organizational
structure, as well as the activities of the board
of directors and the audit committee.
Corporate charter and bylaws
Minutes of meetings

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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 Effectiveness Compliance

reporting and efficiency with laws and
reliability of operations 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 Web site visitors
same-store sales sales/square foot
Performance measurement includes ratio analysis
and benchmarking against key competitors.
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 Learning Objective 4

Assess client business risk.

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 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 misstatement of the financial
statements due to client business risk

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 The Clients Business, Risk, and
Auditors Risk Assessment
Industry and External Environment
Understand Clients Business Operations and Processes
Business and Industry Management and Governance
Objectives and Strategies
Assess Client Measurement and Performance
Business Risk

Assess Risk of
Material Misstatements
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 Learning Objective 5

Perform preliminary
analytical procedures.

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 Preliminary Analytical
Procedures

Comparison of client ratios to industry

or competitor benchmarks provides an
indication of the companys performance.
Analytical procedures are also an important
part of testing throughout the audit.

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 Examples of Planning
Analytical Procedures
Selected Ratios Client Industry
Short-Term Debt-Paying Ability
Current ratio 3.86 5.20
Liquidity Activity Ratio
Inventory turnover 3.46 5.20
Ability to Meet Long-Term Obligations
Debt to equity 1.73 2.51
Profitability
Return on assets 0.09 0.09

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 Summary of the Purposes
of Auditing Planning

A major purpose is to gain an understanding

of the clients business and industry.

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 Key Parts of Planning
Accept Client and Perform
Initial Planning

New client Obtain an

acceptance and understanding
continuance with client
Identify clients
Staff the
reasons for
engagement
the audit
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 Key Parts of Planning
Understand the Clients
Business and Industry

Understand Understand
clients industry clients operations,
and external strategies, and
environment performance system

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 Key Parts of Planning
Assess Client
Business Risk

Assess risk
Assess client
of material
business risk
misstatements
Evaluate management
business controls
affecting business risk
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 Key Parts of Planning
Perform Preliminary
Analytical Procedures

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 Learning Objective 6

State the purposes of analytical

procedures and the timing of
each purpose.

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 Analytical Procedures

Analytical procedures use comparisons and

relationships to assess whether account
balances or other data appear reasonable.
SAS 56 emphasizes the expectations
developed by the auditor.

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 Timing and Purpose of
Analytical Procedures
(Required)
Purpose
Planning Phase
Understand clients
Primary purpose
industry and business
Assess going concern Secondary purpose
Indicate possible misstatements
Primary purpose
(attention directing)
Reduce detailed tests Secondary purpose
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 Timing and Purpose of
Analytical Procedures
Testing
Purpose
Phase
Understand clients
industry and business
Assess going concern
Indicate possible misstatements
Secondary purpose
(attention directing)
Reduce detailed tests Primary purpose
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 Timing and Purpose of
Analytical Procedures
(Required)
Purpose
Completion Phase
Understand clients
industry and business
Access going concern Secondary purpose
Indicate possible misstatements
Primary purpose
(attention directing)
Reduce detailed tests
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 Learning Objective 7

Select the most appropriate

analytical procedure from
among the five major types.

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 Five Major Types of
Analytical Procedures
1. Compare client and industry data.
2. Compare client data with similar
prior-period data.
3. Compare client data with
client-determined expected results.
4. Compare client data with
auditor-determined expected results.
5. Compare client data with expected
results, using nonfinancial data.
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 Compare Client
and Industry Data

Client Industry
2002 2001 2002 2001
Inventory turnover 3.4 3.5 3.9 3.4
Gross margin percent 26.3% 26.4% 27.3% 26.2%

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 Compare Client Data With
Similar Prior-period Data

2002 2001
(000,000) % of (000,000) % of
Preliminary Net Sales Audited Net Sales
Net sales 143 100 131 100
Cost of goods sold 103 72 95 72
Gross profit 40 28 36 28
S &A 32 22 30 23
Other 4 3 3 3
Net income 4 3 3 2

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 Learning Objective 8

Compute common
financial ratios.

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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 ratio:
(Cash + Marketable securities) Current liabilities

Quick ratio:
(Cash + Marketable securities
+ Net accounts receivable) Current liabilities

Current ratio:
Current assets Current liabilities
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 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
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 Liquidity Activity Ratios

Days to sell inventory:

365 days inventory turnover

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 Ability to Meet Long-term
Debt Obligation

Debt to equity:
Total liabilities Total equity

Times interest earned:

Operating income Interest expense

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 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 clients business and industry.

They are used throughout the audit to identify

possible misstatements, reduce detailed tests,
and to assess going-concern issues.
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 End of Chapter 8

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