Chapter 10: Analytical Procedures Flashcards
What are analytical procedures?
tests of reasonableness of financial statements amounts
What is the audit objective of analytical procedures?
to assess RMM or the likelihood that the reported amount is materially misstated
How does an auditor conduct an analytical procedure?
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
In what phases of the audit process are analytical procedures used?
Planning Phase, During the Audit for Use as Substantive Evidence, Final Review Phase
What are the steps of analytical procedures?
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
How do auditor’s develop a prediction of what an amount should be?
Auditors use their judgement regarding how best to develop a prediction
How does an auditor compare the prediction and reported amounts?
Use significant judgement in deciding whether or not the difference between the predicted and reported amount is indicative of problems
What are some common sources of information that are used to develop predictions?
1) Trends in the data, 2) Industry Ratios, 3) Relationships with non-financial data, 4) Budgeted or forecast data
Gross profit percentage ratio
Gross profit/Sales
Cost of Sales Percentage ratio
Cost of Sales/Sales
Inventory Turnover Ratio
Cost of Sales/Inventory
Accounts Receivable Turnover Ratio
Sales/Accounts Receivable
Working Capital Ratio
Current Assets/Current Liabilities
Common sized income statement
Divide each item on I/S by sales
AP Model
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
What do auditor’s need to do in order to properly evaluate the validity of the red flags?
Need to understand and carefully consider the client’s business and the economic and social environment the client is operating in
What does the auditor do if an unusual fluctuation is found?
Ask the client if there is a reasonable explanation for the unexpected fluctuation
What do auditor’s need to know before talking to a client?
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
What do auditor’s do when there is a reasonable explanation for the red flag?
1) Verify the explanation is true, 2) Re-run the AP with new information
What is pattern analysis?
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
