Mcconnel Auditing Chapter 8 Midterm

Front 1

Why do auditors perform preliminary analytical procedures?

Back 1

To better understand the client's business and to assess client business risk.

Front 2

What can preliminary analytical tests reveal?

Back 2

Unusual changes in ratios compared to prior years, or to inventory averages, and help the auditor identify areas with increased risk of misstatements that require further attention during the audit.

Front 3

What may an auditor use ratio information for?

Back 3

To identify areas where companies face increased risk of material misstatement.

Front 4

What is a major purpose of audit planning?

Back 4

To gain an understanding of the client's business industry which is used to assess acceptable audit risk, client business risk, and the risk of material misstatements in financial statements.

Front 5

Define analytical procedures

Back 5

They are defined by auditing standards as evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data...involving comparisons of recorded amounts...to expectations developed by the auditor.

Front 6

What do analytical procedures use?

Back 6

Analytical procedures use comparisons and relationships to assess whether account balances or other data appear reasonable relative to the auditor's expectations.

Front 7

What does the definition of analytical procedures emphasize?

Back 7

The expectations developed by the auditor. For example, the auditor might compare current-year recorded commission expense to an expectation of commission rate as a test of the overall reasonableness of recorded commissions. For this analytical procedure to be relevant and reliable, the auditor has likely concluded that recorded sales are correctly stated, all sales earn a commission, and that the average actual commission rate is readily determinable.

Front 8

Analytical procedures may be performed when in an audit? 3 times.

Back 8

1. REQUIRED in planning phase to assist in determining the nature, extent, and timing of audit procedures.
2. OFTEN done during testing phase as substantive test in support of account balances.
3. REQUIRED during the completion phase.

Front 9

Analytical procedures are REQUIRED in planning phase why?

Back 9

They assist in determining the nature, extent, and timing of audit procedures. This helps auditors identify significant matters requiring special consideration later in the engagement. For example, calculation of inventory turnover before inventory price tests are done may indicate the need for special care during those tests. Analytical procedures done in planning phase typically use data aggregated at a high level and the sophistication, extent, and timing of procedures vary among clients.

Front 10

Analytical procedures are OFTEN done in the planning phase why?

Back 10

AS a substantive test in support of account balances. These tests are often done in conjunction with other audit procedures. For example, prepaid portion of each insurance policy may be compared iwth the same policy for previous year as part of doing tests of prepaid insurance.

Front 11

What does the assurance provided by analytical procedures depend on in the testing phase of the audit?

Back 11

It usually depends on the predictability of the relationship, as well as the precision of the expectation and the reliability of the data used to develop the expectation. When analytical procedures are used during the testing phase auditing standards require auditor to document in working papers expectation and factors considered in its development.

Front 12

When analytical procedures are used in testing phase what are auditors required to do?

Back 12

When analytical procedures are used during the testing phase auditing standards require auditor to document in working papers expectation and factors considered in its development.

Front 13

Analytical procedures REQUIRED in closing phase why?

Back 13

Because they serve as a final review for material misstatements or financial problems and help the auditor take a final "objective look" at the audited financial statements. Typically a senior partner with extensive knowledge of the client's business conducts the analytical procedures during the final review of the audit files and the financial statements to identify possible oversights in an audit.

Front 14

What are the primary purposes of analytical procedures in the planning phase

Back 14

Understand the client's business and industry.
Indicate possible misstatements (attention directing).

Front 15

What are the secondary purposes of Requiring analytical procedures in the planning phase

Back 15

Assessing going concern
Reduce detailed tests

Front 16

When using analytical procedures in the testing phase what is the primary purpose? What is the secondary purpose?

Back 16

Primary: Reduce detailed tests
Indicate possible misstatements (Attention directing)

Front 17

When using analytical procedures in the completion phase what is the primary purpose? What is the secondary purpose?

Back 17

Primary: Indicate possible misstatements (attention directing)
Secondary: Assessing going concern

Front 18

Cash ratio=

Back 18

(Cash + Marketable securities) / Current liabilities

Front 19

What does usefulness of analytical procedures depend on?

Back 19

Depends on the auditor developing an xpectation of what a recorded account balance or ratio should be regardless of the type of analytical procedures used.

Front 20

How do auditors develop an expectation about an account balance?

Back 20

They do this by considering info from prior periods. Compares client's balances and ratios with expectated balances and ratios.

Front 21

What do auditors compare client data with? 5 things

Back 21

1. Industry data
2. Similar Prior-period data
3. Client-determined expected results
4. Auditor-determined expected results
5. Expected results using nonfinancial data

Front 22

Quick ratio=

Back 22

(Cash + Marketable securities + net accounts receivable) / Current liabilities

Front 23

What ratios are helpful in determining short term debt paying ability?

Back 23

Cash ratio
Quick ratio
Current ratio

Front 24

What analysts accumulate industry data auditors use?

Back 24

Dun & Bradstreet, Standard and Poor's, and other analysts.

Front 25

What is a major weakness in using industry ratios for auditing?

Back 25

The difference between the nature of the client's financial information and that of the firms making up the industry totals. Often the client's lineo fbusiness is not the same as industry standards. In addition, different companies folow different accounting methods.

Front 26

Compare client data with similar prior period data 3 options

Back 26

1. Compare current year's balance with preceding year's balance
2. Compare detail of a total balance with similar detail for preceding year
3. Compute ratios and percent relationships for comparison with previous years.

Front 27

Suppose a gross margin percentage for a co has been between 26 and 27 for the last 4 years but then dropped to 23. WHat could the decline be caused by? What are things an auditor would look for?

Back 27

This could be a concern if decline isnt' expceted. Could indicate poor economic conditions, could be caused my misstatement in financials such as sales or purchase cutoff errors, unrecorded sales, overstated acounts payable, or inventory costing errors. The unexpected decline is likely to result in an increase in evidence in one or more of the accounts that affect gross income

Front 28

Compare client data with previous year--COMPARE CURRENT YEAR BALANCE WITH PRECEDING YEAR

Back 28

Easiest way to test this is to include preceding year's adjusted trial balance results in a separate column of the current year's trial balance spreadsheet.
Auditor can easily compare the current year's balance and previous year's balance to decide, early in the audit, whether an account should receive more than the normal amount of attention due to a significant change in the balance.

Front 29

Compare detail of total balance with similar detail for preceding year

Back 29

IF no significant changes in client operations during the year, much of the detail making up the totals in the financial statements should also remain unchanged. By briefly comparing the detail of the current period with similar detail of the preceding period, auditors often isolate info that needs further examination. Comparison of details may take the form of details over time, such as comparing monthly totals for the current year and preceding year for sales, repairs, and other accounts, or details at a point in time. In each example auditors should first develop an expectation of a change or check thereof before making the comparison.

Front 30

COmpute ratios and percent relationships for comparison with previus years

Back 30

COmparing totals or details with prev year has 2 shortcomings.
1. Fails to consider growth or decline in bus activity
2. Relationships of data to other data such as sales to COGS are ignored.
Ratio and percent relationships overcome these shortcomings.

Front 31

Current ratio=

Back 31

Current assets / current liabilities

Front 32

A/R turnover

Back 32

net sales / average gross receivables

Front 33

Common size financial statements

Back 33

These allow for comparison between companies or for the same co over diff time periods, revealing trends, and providing insight into how different companies compare.

Front 34

What should the auditorcalculate income statement account balances as a percent of?

Back 34

Should calculate them as a percent of sales when the level of sales has changed from the pior year - a likely occurrence in many businesses.

Front 35

Compare client data with client determined expected results

Back 35

Most companies prepare budgets which represent the client's expectations for the period. Auditors should investigate the most significant differences between budgeted and actual results, as these areas may contain potential misstatements. The absence of differences may indivate misstatements are unlikely

Front 36

If there is an absence of differences when comparing client data with client determined expected results what does this suggest?

Back 36

that misstatements are unlikely

Front 37

When client data are compared with budgets 2 special concerns arise:

Back 37

1. The auditor must evaluate if the budget plans were realistic.
2. Possibility that current financial info was changed by client personnel to conform to the budget. If this has occurred auditor will find no difference in comparing actual with budget even if there are misstatements.

Front 38

Compare client data with auditor determined expected results

Back 38

Another comparnison occurs when the auditor calculates the expected balance for compraison with the actual balance. IN this typeof procedure auditor makes an estimate of what an account blance should be by relating it to some other balance sheet or income statement account or accounts by making a projection based on nonfinancial data or some historical trend.

Front 39

Compare client data with expected results using nonfinancial data

Back 39

SUppose you are auditing a hotel. You may develop an expectation of total revenue from rooms by multiplying the number of rooms, the average daily rate for each room, and average occupancy rate. You can then compare your estimate with recorded revenue as a test of the reasonableness of recorded revenue. The same apprach can be used to create estimates in other situations such as tuitnion revenue (average tuition x enrollment), factory payroll (Total hrs worked x wage rate), and cost of materials sold (units sold x cost per unit)

Front 40

What is the major concern of using nonfinancial data?

Back 40

The major concern is the accuracy of the data. In the hotel example you should not use an estimated calculation of hotel revenue as audit evidence unless you are satisfied with the reasonableness of the count of the number of rooms, average room rate, and average occupancy rate.

Front 41

Why are general financial ratios useful?

Back 41

For understanding recent events and the financial statuse of the business and for viewing the statements from the perspective of a user.

Front 42

What can general finacial ratios be useful for?

Back 42

Can be helpful in identifying problem areas where the auditor must do additional analysis and audit testing, as well as business problem areas in which the auditor can provide other assistance.

Front 43

When using general financial ratios what must an auditor be sure to do?

Back 43

Must be sure to make appropriate comparisons. Most important comparisons are to those of previous years for the company and to industry averages or similar companies for the same year.

Front 44

Days to collect receivables=

Back 44

365 days / Accounts receivable turnover

Front 45

Inventory turnover

Back 45

COGS / Avg. Inventory

Front 46

Days to sell inventory =

Back 46

365 days / inventory turnover

Front 47

Debt to equity =

Back 47

Total liabilities / total equity

Front 48

Times interest earned

Back 48

operating income / interest expense

Front 49

EPS

Back 49

Net income / Average common shares outstanding

Front 50

Gross profit percent

Back 50

Net sales - COGS / net sales

Front 51

Profit margin

Back 51

operating income / net sales

Front 52

Return on Assets

Back 52

Income before taxes / average total assets

Front 53

Common equity (RETURN ON EQUITY)

Back 53

income before taxes - preferred dividends / average stockholders' equity