ANALYTICAL PROCEDURES SECTION 7
What Are Analytical Procedures? <ul><li>Evaluations of financial information made by a study of plausible relationships am...
<ul><li>Analytical involve comparisons of recorded amounts or ratios to expected amounts </li></ul><ul><li>Expected amount...
Nature of Analytical Procedures <ul><li>Three common types: </li></ul><ul><ul><li>Trend analysis: The analysis of the chan...
<ul><li>Trend Analysis </li></ul><ul><li>Most common approach </li></ul><ul><li>By analyzing changes in an account balance...
<ul><li>Client bought new store on line in November </li></ul><ul><li>Increased sales due to new store </li></ul><ul><li>C...
<ul><li>Simple Trend Analysis </li></ul><ul><li>Involves determining an expected amount based on the account balance in pr...
<ul><li>Regression Analysis </li></ul><ul><li>Sales revenues can be affected by a variety of factors </li></ul><ul><li>Can...
Job Order Costing 40,100 540 12 43,560 815 11 36,600 399 10 43,800 830 9 37,650 460 8 40,750 650 7 30,100 60 6 32,082 101 ...
46,640 45,560 42,480 40,400 38,320 36,240 34,160 32,080 30,000 0 200 400 600 800 1,000 x x x x x x x x x x x x
<ul><li>From the graph </li></ul><ul><li>Y = 30,000 + 16.64X </li></ul><ul><li>Job # 876 uses 962 DLH </li></ul><ul><li>Wh...
<ul><li>Ratio Analysis </li></ul><ul><li>Compares relationships among account balances </li></ul><ul><li>Useful for both i...
<ul><li>Time Series Analysis </li></ul><ul><li>Ratios for an entity compared over time </li></ul><ul><li>Cross-Sectional A...
Time Series Analysis Cross Sectional Analysis Accounts Receivable Turnover Ratio 3.6 3.8 3.8 3.1 3.1 2004 3.5 3.6 3.7 3.2 ...
<ul><li>Methods of Ratio Analysis </li></ul><ul><li>Financial ratios and common size statements </li></ul><ul><li>Financia...
<ul><li>Common-Size Statements </li></ul><ul><ul><li>In preparing common-size statement, the auditor converts the dollar a...
100.0 100.0 100.0 100.0 9.1 8.4 8.1 8.9 Income after tax 5.4 5.1 5.3 5.4 Tax 1.8 3.8 4.6 5.2 Other 20.0 19.4 18.8 18.1 Int...
<ul><li>Use of Industry Ratios </li></ul><ul><ul><li>When performing cross-sectional analysis the auditor may use industry...
<ul><li>Limitations in Using Ratio Analysis </li></ul><ul><ul><li>Different accounting principles can make financial ratio...
<ul><li>Reasonableness Tests </li></ul><ul><li>Computations that calculate an expected amount by using operating data </li...
<ul><li>One period model </li></ul><ul><li>Reasonableness tests typically involve operating data which measures flow over ...
Timing of Analytical Procedures <ul><li>Three phases of an audit: </li></ul><ul><ul><li>Planning </li></ul></ul><ul><ul><l...
<ul><li>Planning </li></ul><ul><li>Analytical procedures can draw attention to audit areas with significant potential for ...
<ul><li>Fieldwork </li></ul><ul><li>Used for substantive testing </li></ul><ul><li>For a test of transactions an balances ...
<ul><li>Final Review </li></ul><ul><li>Analytical procedures are used in the overall or final review stage of the audit to...
Reliability of Data Used to Develop Expectations <ul><li>More reliable if </li></ul><ul><ul><li>From an independent source...
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Download Section 7 - Analytical Procedures

  1. 1. ANALYTICAL PROCEDURES SECTION 7
  2. 2. What Are Analytical Procedures? <ul><li>Evaluations of financial information made by a study of plausible relationships among financial and non-financial data </li></ul><ul><li>Where used? </li></ul><ul><ul><li>Planning </li></ul></ul><ul><ul><li>Substantive tests </li></ul></ul><ul><ul><li>Overall review </li></ul></ul>
  3. 3. <ul><li>Analytical involve comparisons of recorded amounts or ratios to expected amounts </li></ul><ul><li>Expected amounts developed from a variety of sources </li></ul>Similar information regarding the industry in which the entity operates Relationships of elements of financial information within the period Anticipated results, such as budgets or forecasts Financial information from prior periods Example Source of Expected Amount
  4. 4. Nature of Analytical Procedures <ul><li>Three common types: </li></ul><ul><ul><li>Trend analysis: The analysis of the change of an acount over time </li></ul></ul><ul><ul><li>Ratio analysis: A comparison of relationships among financial statement accounts </li></ul></ul><ul><ul><li>Reasonableness Tests: Computations usually involving non-financial data used to estimate an account balance </li></ul></ul>
  5. 5. <ul><li>Trend Analysis </li></ul><ul><li>Most common approach </li></ul><ul><li>By analyzing changes in an account balance over past accounting periods </li></ul><ul><ul><li>The causal approach </li></ul></ul><ul><ul><ul><li>Requires auditor to develop expected results </li></ul></ul></ul><ul><ul><li>The diagnostic approach </li></ul></ul><ul><ul><ul><li>Compare the current amount to the trend to see if the current amount appears to be acceptable </li></ul></ul></ul>
  6. 6. <ul><li>Client bought new store on line in November </li></ul><ul><li>Increased sales due to new store </li></ul><ul><li>Client uses straight line. New store increased fixed asset base. </li></ul><ul><li>Increase % of sales commissions </li></ul><ul><li>OK </li></ul><ul><li>Paid off debt </li></ul><ul><li>Added store location </li></ul>Diagnostic Approach Example 5 4.00 3.30 100 3,100 3,000 R & M Expense 7 4.00 20.00 2,000 12,000 10,000 Utilities Expense 6 4.00 (66.70) 8,000 4,000 12,000 Interest Expense 5 4.00 4.00 320 8,320 8,000 Advertising 5 4.00 4.00 400 10,400 10,000 Office Supplies 4 4.00 32.00 16,000 66,000 50,000 Sales commissions 3 4.00 15.00 12,000 92,000 80,000 Depreciation 2 4.00 10.29 72,000 772,000 700,000 Cost of Sales 1 4.00 11.50 115,000 1,115,000 1,000,000 Sales Explanation Expected Change % Change Change 200Y 200X
  7. 7. <ul><li>Simple Trend Analysis </li></ul><ul><li>Involves determining an expected amount based on the account balance in prior periods </li></ul><ul><li>E.g. A company may have an average annual increase in sales revenue of 10% </li></ul><ul><li>What could be the cause if current years sales did not increase by 10%? </li></ul>
  8. 8. <ul><li>Regression Analysis </li></ul><ul><li>Sales revenues can be affected by a variety of factors </li></ul><ul><li>Can incorporate a number of variables </li></ul><ul><li>Best fit technique </li></ul>
  9. 9. Job Order Costing 40,100 540 12 43,560 815 11 36,600 399 10 43,800 830 9 37,650 460 8 40,750 650 7 30,100 60 6 32,082 101 5 46,010 999 4 44,150 850 3 33,600 220 2 38,340 501 1 Production Cost ($) Direct Labour Hours Observation
  10. 10. 46,640 45,560 42,480 40,400 38,320 36,240 34,160 32,080 30,000 0 200 400 600 800 1,000 x x x x x x x x x x x x
  11. 11. <ul><li>From the graph </li></ul><ul><li>Y = 30,000 + 16.64X </li></ul><ul><li>Job # 876 uses 962 DLH </li></ul><ul><li>What would be the expected job cost? </li></ul><ul><li>But if Job # 876 only cost $42,000 </li></ul><ul><ul><ul><li>Why? </li></ul></ul></ul>
  12. 12. <ul><li>Ratio Analysis </li></ul><ul><li>Compares relationships among account balances </li></ul><ul><li>Useful for both income and balance sheet </li></ul><ul><li>Effective for income statement accounts because it typically compares the variations in operating activity </li></ul>
  13. 13. <ul><li>Time Series Analysis </li></ul><ul><li>Ratios for an entity compared over time </li></ul><ul><li>Cross-Sectional Analysis </li></ul><ul><li>Ratios compared at a given point in time </li></ul>
  14. 14. Time Series Analysis Cross Sectional Analysis Accounts Receivable Turnover Ratio 3.6 3.8 3.8 3.1 3.1 2004 3.5 3.6 3.7 3.2 3.2 2003 3.3 3.5 3.7 3.3 3.2 2002 3.2 3.4 3.5 3.2 3.3 2001 3.3 3.5 3.6 3.0 3.2 2000 3.4 3.6 3.9 2.9 3.2 1999 3.4 3.6 3.9 2.9 3.4 1998 3.5 3.5 3.8 3.0 3.5 1997 Industry Average Firm D Firm C Firm B Firm A
  15. 15. <ul><li>Methods of Ratio Analysis </li></ul><ul><li>Financial ratios and common size statements </li></ul><ul><li>Financial ratios </li></ul><ul><ul><li>Analyzes relationships among account balances that the auditor expects to: </li></ul></ul><ul><ul><ul><li>Remain stable over time </li></ul></ul></ul><ul><ul><ul><li>Be common across firms </li></ul></ul></ul>
  16. 16. <ul><li>Common-Size Statements </li></ul><ul><ul><li>In preparing common-size statement, the auditor converts the dollar amount of each account balance to a percentage of some relevant aggregate amount </li></ul></ul><ul><ul><li>Time-series or cross-sectional </li></ul></ul><ul><ul><li>Generally more useful for income statement accounts </li></ul></ul>
  17. 17. 100.0 100.0 100.0 100.0 9.1 8.4 8.1 8.9 Income after tax 5.4 5.1 5.3 5.4 Tax 1.8 3.8 4.6 5.2 Other 20.0 19.4 18.8 18.1 Interest 23.3 23.4 22.4 21.3 General, selling, and Admin. 40.4 39.9 40.8 41.1 Cost of sales Expenses 100.0 10.0 100.0 100.0 Net sales 3.1 4.0 2.9 2.0 Sales returns 103.1 104.0 102.9 102.0 Sales Revenues 200D 200C 200B 200A Common-Size Income Statement
  18. 18. <ul><li>Use of Industry Ratios </li></ul><ul><ul><li>When performing cross-sectional analysis the auditor may use industry ratios </li></ul></ul><ul><ul><li>Dun and Bradstreet </li></ul></ul><ul><ul><li>840 different classifications </li></ul></ul>
  19. 19. <ul><li>Limitations in Using Ratio Analysis </li></ul><ul><ul><li>Different accounting principles can make financial ratios non-comparable </li></ul></ul><ul><ul><li>Ratios may differ among entities depending upon individual differences </li></ul></ul><ul><ul><li>Auditor should exercise caution when comparing the client with the industry </li></ul></ul>
  20. 20. <ul><li>Reasonableness Tests </li></ul><ul><li>Computations that calculate an expected amount by using operating data </li></ul><ul><li>What could one use if trying to estimate passenger revenue for a bus company or an airline? </li></ul><ul><li>How about total room revenue for a hotel? </li></ul>
  21. 21. <ul><li>One period model </li></ul><ul><li>Reasonableness tests typically involve operating data which measures flow over time </li></ul><ul><li>Can sometimes be excellent for the completeness assertion </li></ul><ul><li>E.g. Expected revenues for an electrical utility </li></ul>
  22. 22. Timing of Analytical Procedures <ul><li>Three phases of an audit: </li></ul><ul><ul><li>Planning </li></ul></ul><ul><ul><li>Fieldwork; and </li></ul></ul><ul><ul><li>Final review </li></ul></ul><ul><li>The purpose of the analytical procedure depends on the audit phase </li></ul>
  23. 23. <ul><li>Planning </li></ul><ul><li>Analytical procedures can draw attention to audit areas with significant potential for misstatement </li></ul><ul><li>They can also enhance understanding of the client’s operations, transactions, and events </li></ul><ul><li>The sophistication of the procedure can vary widely depending on the size and complexity of the client </li></ul><ul><li>Determining risk </li></ul>
  24. 24. <ul><li>Fieldwork </li></ul><ul><li>Used for substantive testing </li></ul><ul><li>For a test of transactions an balances for inventory, what type of procedures can we use? </li></ul><ul><li>How can an analytical procedures supply supporting or corroborating data for accounts receivable? </li></ul>
  25. 25. <ul><li>Final Review </li></ul><ul><li>Analytical procedures are used in the overall or final review stage of the audit to assist the auditor in assessing </li></ul><ul><ul><li>The adequacy of substantive tests. </li></ul></ul><ul><ul><li>The sufficiency of evidence </li></ul></ul><ul><ul><li>The validity of conclusions reached </li></ul></ul><ul><li>Should be performed by a person with in-depth knowledge </li></ul>
  26. 26. Reliability of Data Used to Develop Expectations <ul><li>More reliable if </li></ul><ul><ul><li>From an independent source </li></ul></ul><ul><ul><li>Maintained by people not in a position to manipulate relevant accounting records </li></ul></ul><ul><ul><li>Derived from an adequate internal control structure </li></ul></ul><ul><ul><li>Subjected to audit testing in a prior year </li></ul></ul>

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