1. Chapter 9 Analytical Procedures and Ratios
Dr. Mohamed A. Hamada
Lecturer of AIS

2. Learning Objective
State the purposes of analytical procedures and the timing of each purpose. Select the most appropriate analytical procedure from among the five major types

3. Analytical procedures may be performed at any of three times
Analytical procedures are required in the planning phase to assist in determining the nature, extent, and timing of audit procedures
Analytical procedures are often done during the testing phase of the audit as a substantive test in support of account balances
Analytical procedures are also required during the completion phase of the audit

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

5. 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.

6. Compare Client and Industry Data
2009
2008
2009
2008
Inventory turnover
Gross margin % % % %

7. 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,

8. Example
Suppose that the gross margin percentage between 26 and 27 percent for each of the past 4 years but has dropped to 23 percent in the current year.
This decline in gross margin should be a concern to the auditor if a decline is not expected.
The cause of the decline could be a change in economic conditions.
But, it could also be caused by misstatements in the financial statements, such as sales or purchase cutoff errors, unrecorded sales, overstated accounts payable, or inventory costing errors.

10. Learning Objective 8
Compute common financial ratios.

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

12. 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
*(Stocks , Bonds , Treasury Securities)

14. 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
*the average of the beginning and ending accounts receivable balances for the period

15. Ability to Meet Long-term Debt Obligation
Debt to equity =
Total liabilities
Total equity
Times interest
Earned* =
Operating income
Interest expense
*how many times a company can cover its interest charges. Failing to meet these obligations could force a company into bankruptcy

16. 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

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

18. 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.

19. End of Chapter 8