F8: Audit and Assurance

2 Designed to give you knowledge and application of: Section A: Audit Framework and Regulation Section B: Internal audit Section C: Planning and risk assessment Section D: Internal control Section E: Audit evidence Section F: Review Section G: Reporting

3 Designed to give you the knowledge & application of: Section C: Planning & Risk Assessment C1. Objective & general principles C2. Assessing the risks of material misstament C3. Understanding the entity & its environment C4. Materiality, fraud, laws & regulations C5. Analytical procedures C6. Planning an audit C7. Audit documentation

4 Learning Outcomes C5: Analytical procedures  Describe & explain the nature & purpose of analytical procedures in planning. [2]  Compute & interpret key ratios used in analytical procedures. [2]

5 Analytical procedure  Evaluation of financial information made by a study of plausible relationships among both financial & non-financial data.  Investigation of identified fluctuations & relationships that are inconsistent with other relevant information / deviate significantly from predicted amounts. Describe & explain the nature & purpose of analytical procedures in planning Example Employees 300 Wages (20Y0) $500,000 Employees 200 Wages (20X9) $300,000 Employees 250 Wages $400,000 Budget Actual Wages per employee = Total wages / Number of employees Continued…

6 Steps of analytical procedure Develop an ‘Expectation’ through consideration of relationships (ratio analysis) & comparisons (trend analysis) Compare actuals (recorded financial information) & expectation Any unusual variations between expectation & actual? Ask management for explanations Explanation obtained? Corroborated? Consider need to apply further procedures May limit tests of details of transaction & balances to sample checking No Yes No Yes Continued…

7 trend analysis may cover statistical techniques benchmarking to industry averages / budgets or standards ratio analysis relationship between financial & non- financial information do not give assurance to auditors about all of the assertions made by management in the financial statements. It only provides assurance for the completeness, accuracy & validity of the information Analytical procedures Prior period resultsExpected results Industry average results Results of other comparable divisions of the business Analytical procedure is comparison of financial information of the entity with Continued…

8 Example Cost of material consumed in current year is substantially higher than the corresponding figure for the previous figure. Example Comparison of significant ratios for the entity with those of other entities in the same industry or with the industry average. The planning stage  To identify areas of high audit risk Purpose of analytical procedures The overall review stage  To assess the reasonableness of the reported figure Continued…

9 Example (Particular expense as a percentage of sales) The financial statements of Wonderlands Ltd provide the following information: 20X5 20X6 $ $ Sales30,000 40,000 Sales promotion expenditure 3,00013,000 In this example Sales promotion expense ratio 10% 32.5% (3,000/30,000 x 100) ((13,000/40,000 x 100) In 20X5, the sales promotion ratio was 10% but the sales promotion ratio for 20X6 has increased significantly to 32.5%. This will raise the auditor’s suspicion about the sales promotion expenditure in year 20X6. Compute & interpret key ratios used in analytical procedures

10 Gross Profit ratio Implications / Interpretation  Change in sales / sales mix  Change in gross profit as a result of purchases i.e. rise / fall in purchase cost  Change in other direct expenses Proportion of gross profits to the entity’s turnover Particular expense as a percentage of sales Implications / Interpretation  Change in sales / sales mix  Change in particular expense Proportion of expense to the entity’s turnover Key ratios –Refer to examples on pages 191 to 194 Continued…

11 Current ratio Implications / Interpretation  Whether current assets are sufficient to meet current liabilities.  A low current ratio indicates a high financial risk. Implications / Interpretation  Quick assets (Current assets- inventory) are sufficient to meet current liability requirements.  It should ideally be above one Quick ratio Continued…

12 Average collection period Implications / Interpretation  Reflects number of days it takes for a customer to pay. Implications / Interpretation  Reflects number of days it takes for a company to settle its bills Average payment period Inventory Turnover Implications / Interpretation  Shows number of days inventory has been held in warehouse. Continued…

13 Implications / Interpretation  It shows entity’s capacity to pay the interest Interest cover ratio Dividend cover ratio Implications / Interpretation  Shows entity’s capability to pay dividends  The higher the ratio, the lower the financial risk. Gearing ratio Implications / Interpretation  Measures company’s risk and stability  Expresses relationship between a company’s borrowings and its own funds  A high ratio indicates a high financial risk. Continued…

14 RECAP  Describe & explain the nature & purpose of analytical procedures in planning. [2]  Compute & interpret key ratios used in analytical procedures. [2]