Learning Objective 1: Audit Planning and Analytical Procedures

Learning Objective 1
Discuss why adequate audit

Audit Planning and planning is essential.
Analytical Procedures
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 8-1 ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 8-2
Three Main Reasons for

Risk Terms
Planning
1. To obtain sufficient appropriate evidence ➢ Acceptable audit risk
for the circumstances
➢ Inherent risk
2. To help keep audit costs reasonable
3. To avoid misunderstanding with the client
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-1

Planning an Audit and Planning an Audit and
Designing an Audit Approach Designing an Audit Approach
Accept client and perform initial audit planning. Set materiality and assess acceptable audit risk
and inherent risk.
Understand the client’s business and industry.
Understand internal control and assess control risk.
Assess client business risk.
Gather information to assess fraud risks.
Perform preliminary analytical procedures.
Develop overall audit plan and audit program.
Learning Objective 2 Initial Audit Planning

Make client acceptance decisions 1. Client acceptance and continuance
and perform initial audit planning.
2. Identify client’s reasons for audit
3. Obtain an understanding with the client
4. Develop overall audit strategy

Understanding of the Client’s
Business and Industry
Gain an understanding of the
Factors that have increased the
client’s business and industry. importance of understanding the
client’s business and industry:
➢ Information technology
➢ Global operations
➢ Human capital
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 8-9 ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 8 - 10
Understanding of the Client’s Industry and External

Business and Industry Environment
Understand client’s business and industry Reasons for obtaining an understanding of the
client’s industry and external environment:
Industry and external environment
1. Risks associated with specific industries
Business operations and processes
2. Inherent risks common to all clients in
Management and governance certain industries
3. Unique accounting requirements
Objectives and strategies
Measurement and performance

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 8 - 11 ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 8 - 12

Business Operations
and Processes Tour the Plant and Offices
Factors the auditor should understand: By viewing the physical facilities,
the auditor can asses physical
safeguards over assets and interpret
➢ Major sources of revenue
accounting data related to assets.
➢ Key customers and suppliers
➢ Sources of financing
➢ Information about related parties
Management and Governance

Identify Related Parties
Management establishes the strategies and
A related party is defined as an affiliated processes followed by the client’s business.
company, a principal owner of the client
company, or any other party with which
Governance includes the client’s organizational
the client deals, where one of the parties
structure, as well as the activities of the board
can influence the management or
of directors and the audit committee.
policies of the other.
➢ Corporate charter and bylaws
➢ Code of ethics
➢ Meeting minutes

Client Objectives and Strategies Measurement and Performance
Strategies are approaches followed by the The client’s performance measurement system
entity to achieve organizational objectives. includes key performance indicators. Examples:
Auditors should understand client objectives. ➢ market share ➢ Web site visitors
➢ sales per employee ➢ same-store sales
➢ Financial reporting reliability ➢ unit sales growth ➢ sales/square foot
➢ Effectiveness and efficiency of operations Performance measurement includes ratio analysis
➢ Compliance with laws and regulations and benchmarking against key competitors.
Learning Objective 4 Assess Client Business Risk

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

Client’s Business, Risk, and
Risk of Material Misstatement
Industry and external environment
Perform preliminary analytical
Understand client’s
business and industry
procedures.
Business operations and processes
Management and governance

Assess client business
risk
Objectives and strategies
Assess risk of material Measurement and performance

misstatements
Preliminary Analytical Examples of Planning Analytical

Procedures Procedures
Selected Ratios Client Industry
Comparison of client ratios to industry
or competitor benchmarks provides an Short-term debt-paying ability:
indication of the company’s performance. Current ratio 3.86 5.20
Liquidity activity ratio:
Inventory turnover 3.36 5.20
Preliminary tests can reveal unusual
Ability to meet long-term obligations:
changes in ratios.
Debt to equity 1.73 2.51
Profitability ratio:
Profit margin 0.05 0.07

Summary of the Parts
Key Parts of Planning
of Auditing Planning
A major purpose is to gain an understanding Accept client and perform initial planning
of the client’s business and industry.
➢ New client acceptance and continuance
➢ Identify client’s reasons for audit
➢ Obtain an understanding with client
➢ Staff the engagement
Key Parts of Planning Key Parts of Planning
Understand the client’s business and industry

➢ Assess client business risk
➢ Understand client’s industry and external ➢ Evaluate management controls
environment affecting business risk
➢ Understand client’s operations, strategies, ➢ Assess risk of material misstatements

and performance system

Key Parts of Planning Learning Objective 6
State the purposes of analytical
Perform preliminary analytical procedures
procedures and the timing
of each purpose.
Timing and Purposes of

1. Required in the planning phase (Required) (Required)
Planning Testing Completion
2. Often done during the testing phase Purpose Phase Phase Phase
3. Required during the completion phase Understand client’s Primary
industry and business purpose
Assess going concern Secondary Secondary
purpose purpose
Indicate possible Primary Secondary Primary
misstatements
(attention directing) purpose purpose purpose
Reduce detailed tests Secondary Primary
purpose purpose

Five Types of Analytical
Procedures
Select the most appropriate
Compare client data with:
analytical procedure from
1. Industry data
among the five major types.
2. Similar prior-period data
3. Client-determined expected results
4. Auditor-determined expected results
5. Expected results using nonfinancial data.
Compare Client and Industry Compare Client Data with

Data Similar Prior Period Data
2009 2008
Client Industry
(000) % of (000) % of
2009 2008 2009 2008 Prelim. Net sales Prelim. Net sales
Inventory turnover 3.4 3.5 3.9 3.4 Net sales $143,086 100.0 $131,226 100.0
Cost of goods sold 103,241 72.1 94,876 72.3
Gross margin 26.3% 26.4% 27.3% 26.2% Gross profit $ 39,845 27.9 $ 36,350 27.7
Selling expense 14,810 10.3 12,899 9.8
Administrative expense 17,665 12.4 16,757 12.8
Other 1,689 1.2 2,035 1.6
Earnings before taxes $ 5,681 4.0 $ 4,659 3.5
Income taxes 1,747 1.2 1,465 1.1
Net income $ 3,934 2.8 $ 3,194 2.4

Summary of Analytical
Procedures
They involve the computation of ratios
and other comparisons of recorded End
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.
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1 - 10

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Learning Objective 1

Discuss why adequate audit

Three Main Reasons for

3. To avoid misunderstanding with the client

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-1

Learning Objective 2 Initial Audit Planning

3. Obtain an understanding with the client

4. Develop overall audit strategy

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-2

Understanding of the Client’s Industry and External

Measurement and performance

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-3

Management and Governance

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-4

Learning Objective 4 Assess Client Business Risk

➢ What is the auditor’s primary concern?

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-5

Management and governance

Assess risk of material Measurement and performance

Preliminary Analytical Examples of Planning Analytical

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-6

➢ Identify client’s reasons for audit

➢ Obtain an understanding with client

➢ Staff the engagement

Key Parts of Planning Key Parts of Planning

Understand the client’s business and industry

➢ Understand client’s operations, strategies, ➢ Assess risk of material misstatements

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-7

Timing and Purposes of

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-8

Compare Client and Industry Compare Client Data with

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-9

They are used in planning to understand

They are used throughout the audit to identify

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1 - 10

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