1. Dr. Donald K. McConnell Jr.
Audit of Operations
Dr. Donald K. McConnell Jr.
11/9/2018

2. Audit of Operations
Operating accounts are the revenue and expense accounts (sometimes called “P&L” accounts)
Contemporary emphasis is on reported earnings, yet audits are still primarily balance sheet oriented
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3. How Do We Audit Operations?
Audit of balance sheet accounts indirectly tests operating accounts
Testing controls addresses inputs into operating accounts
Analytical review tests operating accounts
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4. Balance Sheet Substantive Testing
When we audit balance sheet accounts we are indirectly testing inputs into many operating accounts
Examples:
Confirmation of accounts receivable indirectly examines sales
Substantive inventory testing addresses cost of goods sold
The audit of fixed assets tests depreciation
Analysis of notes receivable or payable tests interest expense and income
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5. What Are Tests of Controls?
Procedures to assess the effectiveness of design and operation of internal controls
Test the means, not the results of transaction processing
Must be performed to assess control risk < maximum
Do not directly test dollar amounts
Typically done as dual tests:
Tests of controls
Substantive (dollar amount) tests of transactions
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6. Tests of Controls
Testing controls often addresses controls over operating accounts
Examples: Auditing a sample of 25 randomly selected entries for the nine months ended September 30:
in the sales journal, tests sales
In the purchases journal, tests debits to various expenses (in addition to assets)
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7. Analytical Review of Operating Accounts
Fluctuation (flux) analysis of revenue and expense accounts
Analytical financial statement ratios
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8. How Is Flux Analysis Done?
Obtain trial balance in comparative form with last year
Identify any revenue or expense accounts:
Fluctuating by 10% or more from last year
Where dollar amount of fluctuation exceeds tolerable misstatement
Such accounts would require:
A good client explanation, documented in the work papers, or
Vouching entries exceeding a scope amount in those accounts
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9. Analytical Financial Statement Ratios
Trend analysis of ratios of logically related accounts
To identify unusual fluctuations requiring investigation
Examples:
Gross profit ratio
Inventory turnover ratios: CGS/Avg or ending inventory
Accounts Receivable turnover ratios: Net sales/accounts receivable
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10. Some Operating Accounts Typically Examined in Detail
Certain revenue and expense accounts accounts would be:
Scheduled out in detail items exceeding a scope dollar amount
Vouch those items to supporting invoices, etc. for propriety of:
Classifications
Amounts recorded
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11. Examples: New accounts in the trial balance
Must understand business purpose
May be indicative of misstatements or improper accounting
A personal experience: new credit balance was indicative of illegal management payments!
Legal and professional expense. Why?
Material fluctuations identified analytically
Accounts where errors found in performing tests of controls
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12. More Examples: Accounts Where Errors Commonly Found
Repairs and maintenance expense
Lease expense
Miscellaneous revenue and expense accounts
Suspense accounts
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