Chapter 7 Flashcards
Analytical procedures - Planning stage
Analytical procedures MUST be used as a part of risk assessment at the planning stage under ISA 315.
Analytical procedures - Evidence gathering stage
They may be used as substantive procedures.
In practical terms, the use of substantive analytical procedures involves four distinct steps:
1. Firstly, formulate expectations
2. Secondly, compare expected value with actual recorded amount
3. Thirdly, obtain possible reasons for variance between excepted value and recorded amount
4. Fourthly, evaluate impact of any unresolved differences.
Analytical procedures - Review stage
Analytical procedures must be used at review stage.
Considerations will include:
- Whether the financial statements adequately reflect the information and explanations previously obtained and conclusions previously reached
- Whether the procedures reveal any new factors which may affect presentation or disclosures in financial statements
- Whether the procedures produce results which are consistent with the auditor’s knowledge
- The potential impact of uncorrected misstatements identified during the course of the audit.
Performance ratio - Return on Capital employed
Profit before interest and tax /
equity plus net debt
- where net debt is all borrowings less cash owned
Return on Capital employed - Potential causes
- Changes in return
- Age of plant
- Revaluations of non-current assets
- New loans/overdraft
Return on Capital employed - Audit risks
- Misstated profit
- Unrecorded liabilities
- Overstated cash
- Change in accounting policy
Performance ratio - Return on shareholder funds
Net profit for the year /
share capital + reserves
Performance ratio - Gross profit margin
Gross profit x 100 /
Revenue
Performance ratio - Cost of sales percentage
Cost of sales x 100 /
Revenue
Performance ratio - Operating cost percentage
Operating costs x 100 /
Revenue
Performance ratio - Operating profit margin
Profit before interest and tax x 100 /
Revenue
Gross profit margin - Potential causes
Revenue
- Consistent with price changes?
- Has sales volume been a factor?
- Has the sales mix changed?
- Have new products been launched?
- Effects of currency translation?
Cost of sales
- Impact of raw material price change?
- Foreign currency changes
- Labour changes - rates or quantity?
- Changes in overhead costs
Gross profit margin - Audit risks
Revenue
- Early recognition of revenue
- Cut off issues
- Mistranslation of overseas sales
Cost of sales
- Fraud overstating an expense
- Mistranslation of overseas purchases
- Misclassified costs distorting
- Misstated closing inventory
- Deferring costs into next period
- Change in given cost or estimation (depreciation)
Liquidity ratio - Current ratio
Current Assets /
Current Liabilities
Liquidity ratio - Quick ratio
Current Assets - Inventory /
Current Liabilities
Current and Quick ratio - Potential causes
If low - highlights liquidity problems
if high - poor use of shareholder funds
Potential causes:
- Inventory/ receivables/ payable misstated
- Manipulation ie repayment of liabilities just prior to YE`
Long term solvency ratio - Gearing
Net debt /
Equity x 100
- where net debt is all borrowings less cash owned
Long term solvency ratio - Interest cover
Profit before interest payable /
interest payable
Gearing - Potential causes
- Decrease by upward revaluation of NCA
- Increase by large impairment
- Increase by new finance
- Increase by large cash purchase
Gearing - Audit risks
- Going concern
- Understated liabilities
- Overstated cash
- Misclassified preference shares
Efficiency ratio - Net asset turnover
Revenue /
Capital Employed
Efficiency ratio - Inventory period
Inventories * 365 /
cost of sales
if high - potential obsolescence problems
if low - run risk of running out of inventory
Efficiency ratio - Trade receivable period
Trade Receivables * 365 /
Revenue
A change in this ratio may indicate:
- Bad debt collection problems
- Change in customer base
- Change in terms
Efficiency ratio - Trade payable period
Trade payable * 365 /
Cost of sales
if high - may indicate liquidity problems, risk of supplier ceasing supply, enforcing liquidation
