II. Planning Activities - Analytical Procedures

Question 1

An auditor who performed analytical procedures that compared current-year financial information to the comparable prior period noted a significant increase in net income. Given this result, which of the following expectations of recorded amounts would be unreasonable?

1. A decrease in costs of goods sold as a percentage of sales.
2. A decrease in accounts payable.
3. A decrease in retained earnings.
4. A decrease in notes payable.

Answer 1

A significant increase in net income would result in an increase, not a decrease, in retained earnings.

Note:

• If there is a fixed cost component to inventory (for example, in a manufacturing environment), an increase in production to meet increased sales may result in a decrease in cost of goods sold as a percentage of sales.
• A significant increase in net income may be accompanied by increased cash inflows that could be used to pay down debts, including notes payable. (The same goes for accounts payable as well)

Question 2

Which of the following results of analytical procedures would most likely indicate possible unrecorded liabilities?

1. Current ratio of 2:1 as compared to 5:1 for the prior period.
2. Ratio of accounts payable to total current liabilities of 4:1, compared to 6:1 for the prior period.
3. Accounts payable turnover of 5, compared to 10 for the prior period.
4. Accounts payable balance increase greater than 10% over the prior period.

Answer 2

Ratio of accounts payable to total current liabilities of 4:1, compared to 6:1 for the prior period.

Note: This ratio is total current liabilities divided by A/P. A decrease in this ratio (from 6:1 to 4:1) could be caused by an omission of current liabilities (other than A/P) resulting in the appearance that A/P is a larger proportion of total current liabilities than it should be.

Personal Notes:

• in this question, it is asking about an UNRECORDED LIABILITIES
• All of the other answers could be because of a an increase or a decrease in current liabilities so the others are wrong.

Question 3

The auditor should consider certain factors in assessing the efficiency and effectiveness of analytical procedures as compared to tests of details. In determining whether and to what extent analytical procedures should be used, which of the should the auditor consider?

What are the 4 factors that determine the effectiveness and efficiency of the analytical procedures used for substantive purposes:?

Answer 3

4 factors that determine the effectiveness and efficiency of analytical procedures used for substantive purposes:

• (1) the nature of the assertion,
• (2) the plausibility and predictability of the relationship,
• (3) the availability and reliability of the data used to develop the expectation, and
• (4) the precision of the expectation

Question 4

Which of the following is an analytical procedure that an auditor most likely would perform during the final review stage of an audit?

Answer 4

AICPA Professional Standards indicate that the overall review might include reading the financial statements and considering whether the evidence gathered is adequate to address identified unusual or unexpected balances as well as unusual or unexpected balances or relationships that were not previously identified.

Question 5

Which of the following most likely would cause an auditor to consider whether a client’s financial statements contain material misstatements?

Answer 5

The results of an analytical procedure disclose unexpected differences.

Question 6

Which of the following is an analytical procedure that an auditor most likely would perform when planning an audit?

Answer 6

Comparing current-year balances to budgeted balances

Think: Budgeting has to do with planning.

Question 7

A primary objective of analytical procedures used in the final review stage of an audit is to

Answer 7

Analytical procedures used in the overall review stage of an audit are intended to assist the auditor in assessing the conclusions reached and in evaluating the overall financial statement presentation.

Question 8

Which of the following activities is an analytical procedure an auditor would perform in the final overall review stage of an audit to ensure that the financial statements are free from material misstatement?

Answer 8

Comparing the current and prior year’s financial statements is a legitimate analytical procedure performed both in planning and as a final review.

Question 9

Which of the following statements is correct concerning analytical procedures used in planning an audit engagement?

Answer 9

They usually use financial and nonfinancial data aggregated at a high level.

note: Analytical procedures used in planning often use data aggregated at a high level

Question 10

What is considered an analytical procedure?

Answer 10

• Converting dollar amounts of income statement account balances to percentages of net sales for comparison with industry averages
• Developing the current year’s expected net sales based on the sales trend of similar entities within the same industry
• Estimating the current year’s expected expenses based on the prior year’s expenses and the current year’s budget

Question 11

Analytical procedures used in planning an audit should focus on identifying

Answer 11

Areas that may represent specific risks relevant to the audit.

Note: Analytical procedures are utilized to gain an understanding of the client’s business and to raise questions that will be answered through the application of substantive procedures.

Question 12

For all audits of financial statements made in accordance with generally accepted auditing standards, the use of analytical procedures is required to some extent

In the planning stage

As a substantive test

In the review stage

Answer 12

Yes

No

Yes

note: Analytical procedures are required in planning and in the overall review. They may be used, but are not required, as substantive tests.

Question 13

Which of the following tends to be most predictable for purposes of analytical procedures applied as substantive tests?

Answer 13

Relationships involving income statement accounts tend to be more predictable for analytical review purposes because the income statement accounts represent transactions occurring over a period of time.

Question 14

An auditor’s decision either to apply analytical procedures as substantive tests or to perform tests of transactions and account balances usually is determined by the

Answer 14

Relative effectiveness and efficiency of the tests.

Note: Evidence may be gathered by means of analytical tests (performed as substantive tests), tests of transactions, and tests of details of balances. The decision as to which means to employ is based on the auditor’s judgment of the expected effectiveness and efficiency of the available procedures.

Question 15

Which of the following comparisons would an auditor most likely make in evaluating an entity’s costs and expenses?

Answer 15

The current year’s payroll expense with the prior year’s payroll expense

Note: The best comparison would be current-year and prior-year payroll expense as they are likely to be related to each other. Thus, the prior-year expense can be used to predict likely current-year expense.

If the numbers are materially different, it could indicate the existence of a material misstatement.

Question 16

What procedure would an auditor most likely perform in planning a financial statement audit?

Answer 16

Comparing the financial statements to anticipated results

Note: Comparing the financial statements to anticipated results is an analytical procedure, which would most likely be performed in planning a financial statement audit.

Question 17

Facts on Analytical procedures:

Answer 17

• Analytical procedures used for planning purposes are intended to enhance the auditor’s understanding of the client’s business and identify areas that may represent specific risks relevant to the audit.
• analytical procedures are most effective when they are applied to plausible and predictable relationships, often involving income statement accounts.​(Operating Expense Transactions)
• Analytical procedures usually involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations (not assertions) developed by the auditor (not management).
• Analytical procedures used in planning an audit generally use data aggregated at a high level.
• Analytical procedures do not replace tests of controls. Analytical procedures are required in planning and in the overall review and may be used as substantive procedures.
• Analytical procedures can be more efficient, as well as more effective, than tests of details and transactions in some cases.
• AU-C 315 and AU-C 520 require the use of analytical procedures at both the risk assessment and near completion of the audit, but not as a substantive procedure.
• Analytical procedures for planning purposes are performed to identify the existence of unusual transactions and events.
• substantive analytical procedures are substantive tests which can aid in the detection of material errors by identifying unexpected fluctuations or the absence of expected fluctuations in the relationships between data.
  
  • Such as Material Dollar Misstatements

Note: Basically, any comparison and study of the financial information is an analytical procedure.

Question 18

Analytical procedures can be more efficient, as well as more effective, than tests of details and transactions in some cases.

Answer 18

Cost of goods sold/average inventory.

Why?

Cost of goods sold/average inventory represents the turnover of inventory and provides information related to inventory valuation.

Question 19

Which of the following tends to be most predictable for purposes of analytical procedures applied as substantive procedures?

Answer 19

Relationships involving income statement accounts.

Why?

AU-C 520 indicates that relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts.

Question 20

An auditor’s analytical procedures performed near the end of the audit indicated that the client’s accounts receivable had doubled since the end of the prior year. However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following client explanations most likely would satisfy the auditor?

Answer 20

The client opened a second retail outlet in the current year and its credit sales approximately equaled the older, established outlet.

Note:

This answer is correct because the opening of a second retail outlet with credit sales approximating the older, established outlet, and a consistent credit policy are likely to result in such a situation.

These situation would increase the percentage of doubtful accounts (and not satified the auditor):

The client liberalized its credit standards in the current year and sold much more merchandise to customers with poor credit ratings.

Twice as many accounts receivable were written off in the prior year than in the current year.

A greater percentage of accounts receivable were currently listed in the “more than 90 days overdue” category than in the prior year.

Question 21

What are all the different types of analysis and example of each of them?

Answer 21

Ratio analysis -

• Ratio analysis utilizes the economic relationships between two or more accounts and is used to identify unusual or unexpected changes. This analytical procedure would most likely be used by an auditor in developing relationships among balance sheet accounts when performing a review.

Regression analysis -

• is a statistical technique that can be used to determine the relationship between or among accounts and whether a significant change has occurred. It would most likely be used by an auditor to ascertain the reasonableness of an account balance.

Trend Analysis -

• involves year-to-year comparisons of account balances and other financial data and attempts to predict future balances based on historical changes. It would most likely be used by an auditor for comparative purposes in ascertaining the reasonableness of an account balance.

Question 22

A basic premise underlying the application of analytical procedures is that

Answer 22

Analytical procedures assume that plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary.

Question 23

What are some examples of an analytical procedure?

Answer 23

• Converting dollar amounts of income statement account balances to percentages of net sales for comparison with industry averages.
• Developing the current year’s expected net sales based on the sales trend of similar entities within the same industry.
• Estimating the current year’s expected expenses based on the prior year’s expenses and the current year’s budget.

Question 24

Factors would most likely influence an auditor’s consideration of the reliability of data when performing analytical procedures?

Answer 24

Whether the data were developed under a system with adequate controls.

Question 25

Analytical procedures used in planning an audit should focus on

Answer 25

Analytical procedures used in planning the audit should focus on

(1) enhancing the auditor’s understanding of the client’s business and the transactions and events that have occurred since the last audit and

(2) identifying areas of specific risk to the audit.

Question 26

An example of an analytical procedure is the comparison of

Answer 26

Financial information with similar information regarding the industry in which the entity operates.

Question 27

Analytical procedures performed near the end of an audit suggest that several accounts have unexpected relationships. The results of these procedures most likely would indicate that

Answer 27

When unexpected relationships exist, additional tests of details are generally required to determine whether misstatements exist.

Question 28

An entity’s income statements were misstated due to the recording of journal entries that involved debits and credits to an unusual combination of expense and revenue accounts.

Answer 28

Performing analytical procedures designed to disclose differences from expectations.

Note: Analytical procedures aid in the identification of unusual transactions and events. The recording of debits and credits to an unusual combination of revenue and expense accounts would cause these accounts to behave differently than expected. The performance of analytical procedures designed to disclose differences from expectations would have helped to detect this irregularity.

Question 29

To be effective, analytical procedures in the overall review stage of an audit engagement should be performed by

Answer 29

In the overall review stage, the purpose of analytical procedures is to evaluate the conclusions reached and the overall financial statement presentation. It is best performed by an experienced and knowledgeable individual. A manager or partner who has a comprehensive knowledge of the client’s business and industry would have the experience and knowledge necessary for this review.

Question 30

most useful to an auditor in evaluating the results of an entity’s operations?

Answer 30

current-year revenue to budgeted current-year revenue

Why?

It would tell the auditor how well the entity did compared to the plan. The comparison would also enable the auditor to predict the effects on other income statement accounts, such as related expense accounts.

Question 31

It would tell the auditor how well the entity did compared to the plan. The comparison would also enable the auditor to predict the effects on other income statement accounts, such as related expense accounts.

Answer 31

Relationships involving income statement accounts.

Note: professional standards indicate that relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts.

Question 32

What analytical procedure that an auditor most likely would use while auditing a company’s notes payable?

Answer 32

Multiplying the average outstanding loan balance by the interest rate and comparing the result to interest expense actually recorded.

Note: analytical procedures involve an assumption of the existence of a plausible relationship among financial and nonfinancial information and such a relationship would seem to exist between the average outstanding loan balance, the interest rate, and the resulting interest expense.

Question 33

When performing analytical procedures in the planning stage, the auditor most likely would develop expectations by reviewing which of the following sources of information?

Answer 33

Unaudited information from internal quarterly reports

Question 34

Auditors try to identify predictable relationships when applying analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?

Answer 34

Interest expense.

Why?

specific rate(s) of interest on debt are likely to allow the auditor to have a very specific expectation as to likely interest expense.

Question 35

Specific rate(s) of interest on debt are likely to allow the auditor to have a very specific expectation as to likely interest expense.

Question 36

An auditor most likely would apply analytical procedures near the completion of the audit to

Answer 36

Determine whether additional audit evidence may be needed.

Question 37

An auditor compares year 2 revenues and expenses with those of the prior year and investigates all changes exceeding 10%. By this procedure the auditor would be most likely to learn that

Answer 37

The client changed its capitalization policy for small tools in year 2.

Why?

A change in a capitalization policy is likely to have a large dollar effect, even for small tools. Thus, an investigation would occur and the auditor would learn of the change in policy regarding small tools.

Question 38

Which of the following analytical procedures most likely would be used during the planning stage of an audit?

Answer 38

Comparing current-year to prior-year sales volumes

Comparing the current year’s sales to that of the prior year is an analytical procedure at a high level of aggregation and would normally be done in planning the audit.

Question 39

Which of the following analytical procedures should be applied to the income statement?

Answer 39

Compare the actual revenues and expenses with the corresponding figures of the previous year and investigate significant differences.

Question 40

The primary objective of analytical procedures used near the end of an audit is to

Answer 40

Assist the auditor when forming overall conclusions about the financial statements.

Question 41

An auditor’s decision whether to apply analytical procedures as substantive tests usually is determined by the

Answer 41

Precision and reliability of the data used to develop expectations.

Why?

the data used should be reliable and precise enough to provide the desired level of assurance.

Question 42

An auditor’s analytical procedures most likely would be facilitated if the entity

Answer 42

Uses a standard cost system that produces variance reports.

note: Use of a standard cost system (a form of budgeting) produces variance reports that will allow the auditor to compare the financial information with the standard cost system data to identify unusual fluctuations.

Question 43

What is a reasonableness test?

Answer 43

This test involves comparing an individual’s current overtime per week with a comparable period for reasonableness.

Question 44

An auditor’s decision either to apply analytical procedures as substantive procedures or to perform tests of transactions and account balances usually is determined by the

Answer 44

Relative effectiveness and efficiency of the tests.

Why?

This answer is correct because the decision on the appropriate mix of substantive procedures is based on the auditor’s judgment on the expected effectiveness and efficiency of the available procedures.

Question 45

Which of the following is the most reliable analytical procedure to verify the year-end financial statement balances of a wholesale business?

Answer 45

Verify commission expense by multiplying sales revenue by the company’s standard commission rate.

Note;

Question 46

Which of the following steps should be performed first in applying analytical procedures?

Answer 46

auditors first develop an expectation of a balance or ratio before performing the investigation.

Question 47

A basic premise underlying the application of analytical procedures is that

Answer 47

plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary.

Question 48

Analytical procedures used in the overall review stage of an audit generally include

A primary objective of analytical procedures used near completion of an audit is to

Answer 48

1. Considering unusual or unexpected account balances that were not previously identified.

In other words:

Considering the adequacy of the evidence gathered in response to unexpected balances identified in planning.

2. Assist the auditor in forming overall conclusions about whether the financial statements are consistent with the auditor’s understanding of the company.

Question 49

An auditor compares annual revenues and expenses with similar amounts from the prior year and investigates all changes exceeding 10%. This procedure most likely could indicate that

Answer 49

Unrealized gains from increases in the value of available-for-sale securities were recorded in the income account for trading securities.

• unrealized gains included in the income account for trading securities may result in that account changing by more than 10%, and accordingly being investigated.

Question 50

Not be considered an analytical procedure?

Answer 50

Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics

Note:

Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics does not involve a comparison between an auditor expectation and a recorded balance and would not be considered an analytical procedure. If you considered the error rate to be part of a test of control effort, then clearly it is not an analytical procedure. If you considered the error rate to be part of a substantive procedure intended to verify the validity of an account balance, then it would be classified as a substantive test of details, not an analytical procedure.

Question 51

Which of the following is an analytical procedure that an auditor most likely would perform near completion of an audit?

Answer 51

Reading the financial statements and considering whether there are any unusual or unexpected balances that were not previously identified.

Question 52

When applying analytical procedures during an audit, which of the following is the best approach for developing and evaluating expectations?

Answer 52

Identifying reasonable explanations for unexpected differences before talking to client management.