1. Audit Planning and Analytical Procedures
Chapter 8

2. Learning Objective 1
Discuss why adequate audit
planning is essential.

3. 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

4. Risk Terms
Acceptable audit risk
Inherent risk

5. Planning an Audit and Designing an Audit Approach
Accept client and perform initial audit planning.
Understand the client’s business and industry.
Assess client business risk.
Perform preliminary analytical procedures.

6. 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.

7. Learning Objective 2 Make client acceptance decisions
and perform initial audit planning.

8. Initial Audit Planning
1. Client acceptance and continuance
2. Identify client’s reasons for audit
3. Obtain an understanding with the client
4. Develop overall audit strategy

9. Learning Objective 3 Gain an understanding of the
client’s business and industry.

10. Understanding of the Client’s Business and Industry
Factors that have increased the
importance of understanding the
client’s business and industry:
Information technology
Global operations
Human capital

11. Understanding of the Client’s Business and Industry
Understand client’s business and industry
Industry and external environment
Business operations and processes
Management and governance
Objectives and strategies
Measurement and performance

12. Industry and External Environment
Reasons for obtaining an understanding of the
client’s industry and external environment:
1. Risks associated with specific industries
2. Inherent risks common to all clients in
certain industries
3. Unique accounting requirements

13. Business Operations and Processes
Factors the auditor should understand:
Major sources of revenue
Key customers and suppliers
Sources of financing
Information about related parties

14. Tour the Plant and Offices
By viewing the physical facilities,
the auditor can asses physical
safeguards over assets and interpret
accounting data related to assets.

15. Identify Related Parties
A related party is defined as an affiliated
company, a principal owner of the client
company, or any other party with which
the client deals, where one of the parties
can influence the management or
policies of the other.

16. Management and Governance
Management establishes the strategies and
processes followed by the client’s business.
Governance includes the client’s organizational
structure, as well as the activities of the board
of directors and the audit committee.
Corporate charter and bylaws
Code of ethics
Meeting minutes

17. 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.

18. 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

19. Measurement and Performance
The client’s 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.

20. Learning Objective 4
Assess client business risk.

21. Assess Client Business Risk
Client business risk is the risk that the
client will fail to achieve its objectives.
What is the auditor’s primary concern?
Material misstatements in the financial
statements due to client business risk

22. Client’s Business, Risk, and Risk of Material Misstatement
Industry and external environment
Understand client’s
business and industry
Business operations and processes
Management and governance
Assess client business
risk
Objectives and strategies
Assess risk of material
misstatements
Measurement and performance

23. Sarbanes-Oxley Act The Sarbanes-Oxley Act requires that
management certify it has designed
disclosure controls and procedures to
ensure that material information about
business risks is made known to them.
It also requires that management certify
it has informed the auditor and audit
committee of any significant deficiencies
in internal control.

24. Learning Objective 5
Perform preliminary analytical
procedures.

25. Preliminary Analytical Procedures
Comparison of client ratios to industry
or competitor benchmarks provides an
indication of the company’s performance.
Preliminary tests can reveal unusual
changes in ratios.

26. Examples of Planning Analytical Procedures
Selected Ratios
Client
Industry
Short-term debt-paying ability:
Current ratio
Liquidity activity ratio:
Inventory turnover
Ability to meet long-term obligations:
Debt to equity
Profitability ratio:
Profit margin

27. Summary of the Parts of Auditing Planning
A major purpose is to gain an understanding
of the client’s business and industry.

28. Key Parts of Planning Accept client and perform initial planning
New client acceptance and continuance
Identify client’s reasons for audit
Obtain an understanding with client
Staff the engagement

29. Key Parts of Planning Understand the client’s business and industry
Understand client’s industry and external
environment
Understand client’s operations, strategies,
and performance system

30. Key Parts of Planning Assess client business risk
Evaluate management controls
affecting business risk
Assess risk of material misstatements

31. Key Parts of Planning
Perform preliminary analytical procedures

32. Learning Objective 6 State the purposes of analytical
procedures and the timing
of each purpose.

33. Analytical Procedures
AU 329 emphasizes the expectations
developed by the auditor.
Required in the planning phase
Often done during the testing phase
Required during the completion phase

34. Timing and Purposes of Analytical Procedures
(Required)
Planning
Phase
Testing
Phase
(Required)
Completion
Phase
Understand client’s
industry and business
Primary
purpose
Assess going concern
Secondary
purpose
Secondary
purpose
Indicate possible
misstatements
(attention directing)
Primary
purpose
Secondary
purpose
Primary
purpose
Reduce detailed tests
Secondary
purpose
Primary
purpose

35. Learning Objective 7 Select the most appropriate
analytical procedure from
among the five major types.

36. Five Types of Analytical Procedures
Compare client data with:
1. Industry data
2. Similar prior-period data
3. Client-determined expected results
4. Auditor-determined expected results
5. Expected results using nonfinancial data.

37. Compare Client and Industry Data
2009
2008
2009
2008
Inventory turnover
Gross margin % 26.4% 27.3% 26.2%

38. Compare Client Data with Similar Prior Period Data
2009
2008
(000)
Prelim.
% of
Net sales
(000)
Prelim.
% of
Net sales
Net sales $143, $131,
Cost of goods sold , ,
Gross profit $ 39, $ 36,
Selling expense , ,
Administrative expense , ,
Other , ,
Earnings before taxes $ 5, $ 4,
Income taxes , ,
Net income $ 3, $ 3,

39. Learning Objective 8
Compute common financial ratios.

40. Common Financial Ratios
Short-term debt-paying ability
Liquidity activity ratios
Ability to meet long-term debt obligations
Profitability ratios

41. 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

42. Liquidity Activity Ratios
Accounts receivable
turnover =
Net sales
Average gross receivables
Days to collect
receivable =
365 days
Accounts receivable turnover
Inventory
turnover =
Cost of goods sold
Average inventory
Days to sell
inventory =
365 days
Inventory turnover

43. Ability to Meet Long-term Debt Obligation
Debt to equity =
Total liabilities
Total equity
Times interest
earned =
Operating income
Interest expense

44. Profitability Ratios Earnings per share = Net income
Average common shares outstanding
Gross profit
percent =
(Net sales – Cost of goods sold)
Net sales
Profit margin =
Operating income
Net sales

45. Profitability Ratios Return on assets = Income before taxes
Average total assets
Return on
common
equity =
(Income before taxes
– Preferred dividends)
Average stockholders’ equity

46. 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 client’s business and industry.
They are used throughout the audit to identify
possible misstatements, reduce detailed tests,
and to assess going-concern issues.

47. End of Chapter 8