Chapter 3: Planning the assignment

Question 1

What are the audit strategy roles?

Answer 1

1. set the scope, timing
2. direct the audit and guide the development of the audit plan

Question 2

What is the role of the audit plan?

Answer 2

set out the nature, timing, extent of procedures (include risk assessment procedures) to be performed

Question 3

Name key contents of an overall audit strategy

Answer 3

1. understanding the entity’s environment
2. understanding the accounting and internal control system (policy, and procedures)
3. risk and materiality
4. consequent nature, timing and extent of resources
5. other matters, eg: going concern basis, special attention

Question 4

Why do auditors have to obtain an understanding of the entity and its environment?

Answer 4

1. identify and assess the RoMM
2. design and perform further audit procedures
3. a frame of reference for exercising audit judgment

Question 5

How can auditors obtain an understanding of the entity and its environment?

Answer 5

1. inquiry of mgt
2. analytical procedures
3. observation
4. inspection
5. prior period knowledge
6. discussion among the engagement team

Question 6

Besides understanding the entity’s nature, what else must auditors know in the planning stage?

Answer 6

the entity’s financial reporting framework (accounting policies)

Question 7

Do analytical procedures only consider financial data?

Answer 7

No. Both financial and non-financial data

Question 8

What do analytical procedures at the planning stage include?

Answer 8

1. consideration of comparison: prior periods, budgeted, forecasts, expectations, similar industry information
2. consideration of relationships: non-financial data, elements of financial information which created a patterns

Question 9

Name 4 main accounting ratio which may be used as analytical procedures

Answer 9

1. performance ratio
2. short-term liquidity ratios
3. long-term solvency ratios
4. efficiency ratios

Question 10

What is the formula to calculate the return on capital employed? State its purpose

Answer 10

1) PBIT/ equity + net debt
2) purpose: effective use of resources

Question 11

What is the formula to calculate the return on shareholders’ funds? State its purpose

Answer 11

1) net profit for the period/ share capital + reserves
2) purpose: effective use of resources

Question 12

What is the formula to calculate the gross profit margin? State its purpose

Answer 12

1) gross profit x 100/ revenue
2) purpose: assess profitability before taking overheads

Question 13

What is the formula to calculate the cost of sale percentage? State its purpose

Answer 13

1) cost of sales x 100/ revenue
2) purpose: assess the relationship of costs to revenue

Question 14

What is the formula to calculate the operating cost percentage? State its purpose

Answer 14

1) operating costs x 100/ revenue
2) purpose: assess the relationship of costs to revenue

Question 15

What is the formula to calculate the net margin (operating margin)? State its purpose

Answer 15

1) PBIT x 100/ revenue
2) purpose: assess profitability after taking overheads

Question 16

What is the formula to calculate the current ratio? State its purpose

Answer 16

1) current asset/ current liabilities
2) purpose: assess ability to pay current liabilities from reasonably liquid asset

Question 17

What is the formula to calculate the quick ratio? State its purpose

Answer 17

1) receivables + current investment + cash/ current liabilities
2) purpose: assess ability to pay current liabilities from reasonably liquid asset

Question 18

What is the formula to calculate the gearing ratio? State its purpose

Answer 18

1) net debt/ equity x 100
2) purpose: asset reliance on external finance

Question 19

What is the formula to calculate the interest cover? State its purpose

Answer 19

1) profit before interest payable/ interest payable
2) purpose: assess the ability to pay interest charges

Question 20

What is the formula to calculate the net asset turnover? State its purpose

Answer 20

1) revenue/ capital employed
2) purpose: assess revenue generated from asset base

Question 21

What is the formula to calculate the inventory turnover? State its purpose

Answer 21

1) costs of sales/ inventories
2) purpose: assess level of inventory held

Question 22

What is the formula to calculate the inventory days? State its purpose

Answer 22

1) average inventory/ cost of sales x 365
2) purpose: assess the average inventory-holding period

Question 23

What is the formula to calculate the trade receivables collection period? State its purpose

Answer 23

1) trade receivables x 365/ revenue
2) purpose: assess ability to turn receivables into cash

Question 24

What is the formula to calculate the trade payables payment period? State its purpose

Answer 24

1) trade payables x 365/ credit purchases
2) purpose: assess ability to pay suppliers