Chapter 10: Analytical Procedures

Question 1

What are analytical procedures?

Answer 1

tests of reasonableness of financial statements amounts

Question 2

What is the audit objective of analytical procedures?

Answer 2

to assess RMM or the likelihood that the reported amount is materially misstated

Question 3

How does an auditor conduct an analytical procedure?

Answer 3

1) use information (past year’s F/S) to develop a prediction about what some reported amount should be, 2) Compares that prediction to the amount being reported, 3) Uses the comparison to assess the likelihood that the reported amount is materially misstated

Question 4

In what phases of the audit process are analytical procedures used?

Answer 4

Planning Phase, During the Audit for Use as Substantive Evidence, Final Review Phase

Question 5

What are the steps of analytical procedures?

Answer 5

1) Develop a prediction of what some reported amount should be, 2) Use the prediction to assess the likelihood that the amount actually being reported by management is materially misstated

Question 6

How do auditor’s develop a prediction of what an amount should be?

Answer 6

Auditors use their judgement regarding how best to develop a prediction

Question 7

How does an auditor compare the prediction and reported amounts?

Answer 7

Use significant judgement in deciding whether or not the difference between the predicted and reported amount is indicative of problems

Question 8

What are some common sources of information that are used to develop predictions?

Answer 8

1) Trends in the data, 2) Industry Ratios, 3) Relationships with non-financial data, 4) Budgeted or forecast data

Question 9

Gross profit percentage ratio

Answer 9

Gross profit/Sales

Question 10

Cost of Sales Percentage ratio

Answer 10

Cost of Sales/Sales

Question 11

Inventory Turnover Ratio

Answer 11

Cost of Sales/Inventory

Question 12

Accounts Receivable Turnover Ratio

Answer 12

Sales/Accounts Receivable

Question 13

Working Capital Ratio

Answer 13

Current Assets/Current Liabilities

Question 14

Common sized income statement

Answer 14

Divide each item on I/S by sales

Question 15

AP Model

Answer 15

1) Apply the AP, 2) Is there a red flag?, 3) Yes: Is there a valid explanation?, No: Assess RMM as normal or possibly low, 4) Yes: Assess RMM as normal or possibly low, No: Assess RMM as high

Question 16

What do auditor’s need to do in order to properly evaluate the validity of the red flags?

Answer 16

Need to understand and carefully consider the client’s business and the economic and social environment the client is operating in

Question 17

What does the auditor do if an unusual fluctuation is found?

Answer 17

Ask the client if there is a reasonable explanation for the unexpected fluctuation

Question 18

What do auditor’s need to know before talking to a client?

Answer 18

1) Know who to talk to, 2) Be prepared and know exactly what you’re going to ask, 3) Make sure you fully understand and document the client’s answer before leaving

Question 19

What do auditor’s do when there is a reasonable explanation for the red flag?

Answer 19

1) Verify the explanation is true, 2) Re-run the AP with new information

Question 20

What is pattern analysis?

Answer 20

Auditor takes into consideration all of the AP findings for related accounts together in order to try and determine what error/fraud might have occurred to cause the unusual fluctuations