Audit & Assurance: Analytical Procedures Flashcards
2 purposes of analytical procedures in audit planning
- gain better understanding of client
2. identify accounts at risk of material misstatement
3 types of analysis
- horizontal: trend analysis
- vertical: common-size analysis
- ratio analysis
Accounts receivable turnover: description and audit context
= net credit sales / average AR
_determines how quickly the company is collecting receivables & turning them into cash
_decreasing ARTR indicates risk of uncollectable receivables or that they have been overstated
_perform receipt testing (AR GL to bank balance), send account receivable confirmations to customers
Inventory turnover & days sales: description and audit context
= COGS / average inventory
_determines how quickly the company is selling inventory
_decreasing ITR indicates risk of old, unsaleable inventory or overvalued inventory
_inspect inventory for damages, agree items to inventory balance, check NRV (recent sales invoices)
Current ratio: description & audit context
=current assets/current liabilities
_AKA working capital ratio
_decreasing CR sign of going-concern issue; not enough cash on hand to meet ST-obligations, current items could be overstated
_analyze CF projections, discuss with management, confirm reasonability of inputs (eg published industry trends); test specific current accounts
Debt-to-Equity ratio: Description & audit context
=debt/equity
_measure of solvency
_increasing D/E could be sign of going-concern issue
_analyze CF projections & discuss with mgt, confirm reasonability of inputs (eg industry trends); test specific accounts eg bank confirmation
Gross profit margin: Description & audit context
=(revenue - COGS)/revenue
_determines profit per dollar of sales available for overhead
_increasing GM could indicate cut-off errors; may indicate overstated rev/understated COGS
_vouch sample of sales entries; trace unit costs; sample shipping docs before & after year end; vouch sales entries before & after year end
Income statement account: Bad debt expense
What is the related balance sheet account?
Accounts receivable
Allowance for doubtful accounts
Income statement accounts: Advertising expense, rent expense, property tax expense
What is the related balance sheet account?
Prepaid expenses
Income statement accounts: Depreciation expense, repairs and maintenance
What is the related balance sheet account?
PPE
Income statement account: Property tax expense
What is the related balance sheet account?
Land and buildings within PPE
Income statement account: Interest expense
What is the related balance sheet account?
Long-term debt
Income statement account: Sales, warranty expense
What is the related balance sheet account?
Accounts receivable
Warranty liability
Income statement account: Professional fees
What is the related balance sheet account?
Contingent liabilities
working capital
current assets - current liabilities
A high debt-to-equity ratio is a negative or positive qualitative factor?
negative
Which of these ratios would a bank loan officer use to determine the financial leverage of a company?
working capital ratio
debt-to-equity ratio
Debt-to-equity ratio; this indicates the proportion of equity and debt the company is using to finance its assets which is a measure of financial leverage.
Working capital ratio is a measure of liquidity
True or false: Contribution margin analysis is useful in evaluating a company’s ability to manage its productive assets efficently.
False. Contribution margin will demonstrate if a product is priced to cover its costs, but does not provide information about the company’s ability to manage assets efficiently because it does not indicate whether a better return could be generated by redirecting resources to other products.
True or false: The most useful analytical tool to assess long-run solvency is the solvency ratio
True. The solvency ratio is often used by banks to assess a company’s ability to repay its debt over time.
Solvency ratio
=(after tax net income + depreciation & amortization)/all liabilities
