8 - 1 ©2006 prentice hall business publishing, auditing 11/e, arens/beasley/elder audit planning...

8 - 1©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder

Audit Planning andAudit Planning andAnalytical Analytical ProceduresProcedures

Chapter 8Chapter 8


Learning Objective 1Learning Objective 1

Discuss why adequate auditDiscuss why adequate audit

planning is essential.planning is essential.


Three Main Reasons for PlanningThree Main Reasons for Planning

To obtain sufficient competent evidenceTo obtain sufficient competent evidencefor the circumstancesfor the circumstances

To obtain sufficient competent evidenceTo obtain sufficient competent evidencefor the circumstancesfor the circumstances

To help keep audit costs reasonableTo help keep audit costs reasonableTo help keep audit costs reasonableTo help keep audit costs reasonable

To avoid misunderstanding with the clientTo avoid misunderstanding with the clientTo avoid misunderstanding with the clientTo avoid misunderstanding with the client


Risk TermsRisk Terms

Acceptable audit riskAcceptable audit riskAcceptable audit riskAcceptable audit risk

Inherent riskInherent riskInherent riskInherent risk


Planning an Audit and Designing Planning an Audit and Designing an Audit Approachan Audit Approach

Accept client andAccept client andperform initialperform initialaudit planning.audit planning.

Accept client andAccept client andperform initialperform initialaudit planning.audit planning.

Understand the client’sUnderstand the client’sbusiness and industry.business and industry.

Understand the client’sUnderstand the client’sbusiness and industry.business and industry.

Assess client businessAssess client businessrisk.risk.


Perform preliminaryPerform preliminaryanalytical procedures.analytical procedures.

Perform preliminaryPerform preliminaryanalytical procedures.analytical procedures.


Planning an Audit and Designing Planning an Audit and Designing an Audit Approachan Audit Approach

Set materiality andSet materiality andassess acceptable auditassess acceptable auditrisk and inherent risk.risk and inherent risk.

Set materiality andSet materiality andassess acceptable auditassess acceptable auditrisk and inherent risk.risk and inherent risk.

Understand internalUnderstand internalcontrol and assesscontrol and assesscontrol risk.control risk.

Understand internalUnderstand internalcontrol and assesscontrol and assesscontrol risk.control risk.

Gather information toGather information toassess fraud risks.assess fraud risks.

Gather information toGather information toassess fraud risks.assess fraud risks.

Develop overall auditDevelop overall auditplan and audit program.plan and audit program.

Develop overall auditDevelop overall auditplan and audit program.plan and audit program.



Make client acceptance decisionsMake client acceptance decisions

and perform initial audit planning.and perform initial audit planning.


Initial Audit PlanningInitial Audit Planning

Get client acceptance and continuance.Get client acceptance and continuance.Get client acceptance and continuance.Get client acceptance and continuance.

Identify client’s reasons for audit.Identify client’s reasons for audit.Identify client’s reasons for audit.Identify client’s reasons for audit.

Obtain an understanding with the client.Obtain an understanding with the client.Obtain an understanding with the client.Obtain an understanding with the client.

Select staff for the engagement.Select staff for the engagement.Select staff for the engagement.Select staff for the engagement.

Evaluate need for outside specialists.Evaluate need for outside specialists.Evaluate need for outside specialists.Evaluate need for outside specialists.



Gain an understanding of theGain an understanding of the

client’s business and industry.client’s business and industry.


Understanding of the Client’s Understanding of the Client’s Business and IndustryBusiness and Industry

What are some factors that have increasedWhat are some factors that have increasedthe importance of understanding thethe importance of understanding theclient’s business and industry?client’s business and industry?

What are some factors that have increasedWhat are some factors that have increasedthe importance of understanding thethe importance of understanding theclient’s business and industry?client’s business and industry?

Global operationsGlobal operationsGlobal operationsGlobal operations

Information technologyInformation technologyInformation technologyInformation technology

Human capitalHuman capitalHuman capitalHuman capital


Understanding of the Client’s Understanding of the Client’s Business and IndustryBusiness and Industry

Industry and external environmentIndustry and external environment Industry and external environmentIndustry and external environment

Business operations and processesBusiness operations and processesBusiness operations and processesBusiness operations and processes

Management and governanceManagement and governanceManagement and governanceManagement and governance

Objectives and strategiesObjectives and strategiesObjectives and strategiesObjectives and strategies

Measurement and performanceMeasurement and performanceMeasurement and performanceMeasurement and performance

Understand client’s business and industry.Understand client’s business and industry.Understand client’s business and industry.Understand client’s business and industry.


Industry and External Industry and External EnvironmentEnvironment

What are some reasons for obtaining anWhat are some reasons for obtaining an understanding of the client’s industry understanding of the client’s industry and external environment?and external environment?

What are some reasons for obtaining anWhat are some reasons for obtaining an understanding of the client’s industry understanding of the client’s industry and external environment?and external environment?

1.1. Risks associated with specific industriesRisks associated with specific industries2.2. Inherent risks common to all clients inInherent risks common to all clients in certain industriescertain industries3.3. Unique accounting requirementsUnique accounting requirements

1.1. Risks associated with specific industriesRisks associated with specific industries2.2. Inherent risks common to all clients inInherent risks common to all clients in certain industriescertain industries3.3. Unique accounting requirementsUnique accounting requirements


Business OperationsBusiness Operationsand Processesand Processes

Factors the auditor should understand:Factors the auditor should understand:Factors the auditor should understand:Factors the auditor should understand:

– – Major sources of revenueMajor sources of revenue– – Key customers and suppliersKey customers and suppliers– – Sources of financingSources of financing– – Information about related partiesInformation about related parties– – Ability to obtain financingAbility to obtain financing

– – Major sources of revenueMajor sources of revenue– – Key customers and suppliersKey customers and suppliers– – Sources of financingSources of financing– – Information about related partiesInformation about related parties– – Ability to obtain financingAbility to obtain financing


Management and GovernanceManagement and Governance

Management establishes the strategies andManagement establishes the strategies andprocesses followed by the client’s business.processes followed by the client’s business.

Management establishes the strategies andManagement establishes the strategies andprocesses followed by the client’s business.processes followed by the client’s business.

Governance includes the client’s organizationalGovernance includes the client’s organizationalstructure, as well as the activities of the boardstructure, as well as the activities of the boardof directors and the audit committee.of directors and the audit committee.

Governance includes the client’s organizationalGovernance includes the client’s organizationalstructure, as well as the activities of the boardstructure, as well as the activities of the boardof directors and the audit committee.of directors and the audit committee.

Corporate charter and bylawsCorporate charter and bylawsCorporate charter and bylawsCorporate charter and bylaws

Meeting minutesMeeting minutesMeeting minutesMeeting minutesCode of ethicsCode of ethicsCode of ethicsCode of ethics


Code of EthicsCode of Ethics

In response to the Sarbanes-Oxley Act, the SECIn response to the Sarbanes-Oxley Act, the SECnow requires each public company to disclosenow requires each public company to disclosewhether is has adopted a code of ethics thatwhether is has adopted a code of ethics thatapplies to senior management.applies to senior management.

In response to the Sarbanes-Oxley Act, the SECIn response to the Sarbanes-Oxley Act, the SECnow requires each public company to disclosenow requires each public company to disclosewhether is has adopted a code of ethics thatwhether is has adopted a code of ethics thatapplies to senior management.applies to senior management.

The SEC also requires companies to discloseThe SEC also requires companies to discloseamendments and waivers to the code of ethics.amendments and waivers to the code of ethics.

The SEC also requires companies to discloseThe SEC also requires companies to discloseamendments and waivers to the code of ethics.amendments and waivers to the code of ethics.


Client Objectives and StrategiesClient Objectives and Strategies

Strategies are approaches followed by theStrategies are approaches followed by theentity to achieve organizational objectives.entity to achieve organizational objectives.

Strategies are approaches followed by theStrategies are approaches followed by theentity to achieve organizational objectives.entity to achieve organizational objectives.

Auditors should understand client objectives.Auditors should understand client objectives.Auditors should understand client objectives.Auditors should understand client objectives.

Effectiveness and efficiency of operationsEffectiveness and efficiency of operations Effectiveness and efficiency of operationsEffectiveness and efficiency of operations

Financial reporting reliabilityFinancial reporting reliability Financial reporting reliabilityFinancial reporting reliability

Compliance with laws and regulationsCompliance with laws and regulations Compliance with laws and regulationsCompliance with laws and regulations


Measurement and PerformanceMeasurement and Performance

The client’s performance measurement systemThe client’s performance measurement systemincludes key performance indicators. Examples:includes key performance indicators. Examples:

The client’s performance measurement systemThe client’s performance measurement systemincludes key performance indicators. Examples:includes key performance indicators. Examples:

– – market sharemarket share– – sales per employeesales per employee– – unit sales growthunit sales growth

– – market sharemarket share– – sales per employeesales per employee– – unit sales growthunit sales growth

– – Web site visitorsWeb site visitors– – same-store salessame-store sales– – sales/square footsales/square foot

– – Web site visitorsWeb site visitors– – same-store salessame-store sales– – sales/square footsales/square foot

Performance measurement includes ratio analysisPerformance measurement includes ratio analysisand benchmarking against key competitors.and benchmarking against key competitors.

Performance measurement includes ratio analysisPerformance measurement includes ratio analysisand benchmarking against key competitors.and benchmarking against key competitors.



Assess client business risk.Assess client business risk.


Assess Client Business RiskAssess Client Business Risk

Client business riskClient business risk is the risk that the is the risk that theclient will fail to achieve its objectives.client will fail to achieve its objectives.

Client business riskClient business risk is the risk that the is the risk that theclient will fail to achieve its objectives.client will fail to achieve its objectives.

What is the auditor’s primary concern?What is the auditor’s primary concern?What is the auditor’s primary concern?What is the auditor’s primary concern?

– – material misstatements in the financialmaterial misstatements in the financialstatements due to client business riskstatements due to client business risk

– – material misstatements in the financialmaterial misstatements in the financialstatements due to client business riskstatements due to client business risk


Assess Client Business RiskAssess Client Business Risk

The Sarbanes-Oxley Act requires thatThe Sarbanes-Oxley Act requires that management certify it has designedmanagement certify it has designeddisclosure controls and procedures todisclosure controls and procedures toensure that material information aboutensure that material information aboutbusiness risks is made known to them.business risks is made known to them.

The Sarbanes-Oxley Act requires thatThe Sarbanes-Oxley Act requires that management certify it has designedmanagement certify it has designeddisclosure controls and procedures todisclosure controls and procedures toensure that material information aboutensure that material information aboutbusiness risks is made known to them.business risks is made known to them.

It also requires that management certifyIt also requires that management certifyit has informed the auditor and auditit has informed the auditor and auditcommittee of any significant deficienciescommittee of any significant deficienciesin internal control.in internal control.

It also requires that management certifyIt also requires that management certifyit has informed the auditor and auditit has informed the auditor and auditcommittee of any significant deficienciescommittee of any significant deficienciesin internal control.in internal control.


The Client’s Business, Risk, andThe Client’s Business, Risk, andAuditor’s Risk AssessmentAuditor’s Risk Assessment

Understand client’sUnderstand client’sbusiness and industry.business and industry.

Understand client’sUnderstand client’sbusiness and industry.business and industry.

Industry and external environmentIndustry and external environmentIndustry and external environmentIndustry and external environment

Business operations and processesBusiness operations and processesBusiness operations and processesBusiness operations and processes

Management and governanceManagement and governanceManagement and governanceManagement and governance

Objectives and strategiesObjectives and strategiesObjectives and strategiesObjectives and strategies

Measurement and performanceMeasurement and performanceMeasurement and performanceMeasurement and performance



Assess risk of materialAssess risk of materialmisstatements.misstatements.

Assess risk of materialAssess risk of materialmisstatements.misstatements.


Enterprise Risk ManagementEnterprise Risk Management

Enterprise risk management (ERM) hasEnterprise risk management (ERM) hasemerged as a new paradigm for managing risk.emerged as a new paradigm for managing risk.

Enterprise risk management (ERM) hasEnterprise risk management (ERM) hasemerged as a new paradigm for managing risk.emerged as a new paradigm for managing risk.

ERM integrates and coordinates riskERM integrates and coordinates riskmanagement across the entire enterprise.management across the entire enterprise.

ERM integrates and coordinates riskERM integrates and coordinates riskmanagement across the entire enterprise.management across the entire enterprise.

What’s aWhat’s aparadigm?paradigm?

Go lookGo lookit up!it up!



Perform preliminary analyticalPerform preliminary analytical

procedures.procedures.


Preliminary Analytical ProceduresPreliminary Analytical Procedures

Comparison of client ratios to industryComparison of client ratios to industryor competitor benchmarks provides anor competitor benchmarks provides anindication of the company’s performance.indication of the company’s performance.

Comparison of client ratios to industryComparison of client ratios to industryor competitor benchmarks provides anor competitor benchmarks provides anindication of the company’s performance.indication of the company’s performance.

Analytical procedures are also an importantAnalytical procedures are also an importantpart of testing throughout the audit.part of testing throughout the audit.

Analytical procedures are also an importantAnalytical procedures are also an importantpart of testing throughout the audit.part of testing throughout the audit.


Examples of Planning Analytical Examples of Planning Analytical ProceduresProcedures

Liquidity activity ratio:Liquidity activity ratio:Inventory turnoverInventory turnover 3.363.36 5.205.20

Liquidity activity ratio:Liquidity activity ratio:Inventory turnoverInventory turnover 3.363.36 5.205.20

Ability to meet long-term obligations:Ability to meet long-term obligations:Debt to equityDebt to equity 1.731.73 2.512.51

Ability to meet long-term obligations:Ability to meet long-term obligations:Debt to equityDebt to equity 1.731.73 2.512.51

Profitability ratio:Profitability ratio:Profit marginProfit margin 0.050.05 0.070.07

Profitability ratio:Profitability ratio:Profit marginProfit margin 0.050.05 0.070.07

Short-term debt-paying ability:Short-term debt-paying ability:Current ratioCurrent ratio 3.863.86 5.205.20

Short-term debt-paying ability:Short-term debt-paying ability:Current ratioCurrent ratio 3.863.86 5.205.20

ClientClient IndustryIndustrySelected RatiosSelected Ratios


Summary of the PurposesSummary of the Purposesof Auditing Planningof Auditing Planning

A major purpose is to gain an understanding A major purpose is to gain an understanding of the client’s business and industry.of the client’s business and industry.

A major purpose is to gain an understanding A major purpose is to gain an understanding of the client’s business and industry.of the client’s business and industry.


Key Parts of PlanningKey Parts of Planning

Accept client and performAccept client and performinitial planninginitial planning

Accept client and performAccept client and performinitial planninginitial planning

New clientNew clientacceptance andacceptance andcontinuancecontinuance

New clientNew clientacceptance andacceptance andcontinuancecontinuance

Identify client’sIdentify client’sreasons for auditreasons for audit

Identify client’sIdentify client’sreasons for auditreasons for audit

Obtain anObtain anunderstandingunderstandingwith clientwith client

Obtain anObtain anunderstandingunderstandingwith clientwith client

Staff theStaff theengagementengagement

Staff theStaff theengagementengagement



Understand the client’sUnderstand the client’sbusiness and industrybusiness and industry

Understand the client’sUnderstand the client’sbusiness and industrybusiness and industry

Understand client’sUnderstand client’sindustry and externalindustry and externalenvironmentenvironment

Understand client’sUnderstand client’sindustry and externalindustry and externalenvironmentenvironment

Understand client’sUnderstand client’soperations, strategies,operations, strategies,and performanceand performancesystemsystem

Understand client’sUnderstand client’soperations, strategies,operations, strategies,and performanceand performancesystemsystem



Assess client business riskAssess client business riskAssess client business riskAssess client business risk

Assess clientAssess clientbusiness riskbusiness risk

Assess clientAssess clientbusiness riskbusiness risk

Evaluate management controlsEvaluate management controlsaffecting business riskaffecting business risk

Evaluate management controlsEvaluate management controlsaffecting business riskaffecting business risk

Assess riskAssess riskof materialof materialmisstatementsmisstatements

Assess riskAssess riskof materialof materialmisstatementsmisstatements



Perform preliminary analytical proceduresPerform preliminary analytical proceduresPerform preliminary analytical proceduresPerform preliminary analytical procedures



State the purposes of analyticalState the purposes of analytical

procedures and the timingprocedures and the timing

of each purpose.of each purpose.


Analytical ProceduresAnalytical Procedures

Analytical procedures use comparisons andAnalytical procedures use comparisons andrelationships to assess whether accountrelationships to assess whether accountbalances or other data appear reasonable.balances or other data appear reasonable.

Analytical procedures use comparisons andAnalytical procedures use comparisons andrelationships to assess whether accountrelationships to assess whether accountbalances or other data appear reasonable.balances or other data appear reasonable.

SAS 56 emphasizes the expectationsSAS 56 emphasizes the expectationsdeveloped by the auditor.developed by the auditor.

SAS 56 emphasizes the expectationsSAS 56 emphasizes the expectationsdeveloped by the auditor.developed by the auditor.


Timing and Purposes of Analytical Timing and Purposes of Analytical ProceduresProcedures

(Required)(Required)Planning PhasePlanning PhasePurposePurpose

Understand client’sUnderstand client’sindustry and businessindustry and business Primary purposePrimary purpose

Assess going concernAssess going concern Secondary purposeSecondary purpose

Indicate possible misstatementsIndicate possible misstatements(attention directing)(attention directing) Primary purposePrimary purpose

Reduce detailed testsReduce detailed tests Secondary purposeSecondary purpose



Testing PhaseTesting PhasePurposePurpose

Understand client’sUnderstand client’sindustry and businessindustry and business

Assess going concernAssess going concern

Indicate possible misstatementsIndicate possible misstatements(attention directing)(attention directing) Secondary purposeSecondary purpose

Reduce detailed testsReduce detailed tests Primary purposePrimary purpose



(Required)(Required)Completion PhaseCompletion PhasePurposePurpose

Understand client’sUnderstand client’sindustry and businessindustry and business

Assess going concernAssess going concern Secondary purposeSecondary purpose

Indicate possible misstatementsIndicate possible misstatements(attention directing)(attention directing) Primary purposePrimary purpose

Reduce detailed testsReduce detailed tests



Select the most appropriateSelect the most appropriate

analytical procedure fromanalytical procedure from

among the five major types.among the five major types.


Five Types of Analytical Five Types of Analytical ProceduresProcedures

1.1. Compare client and industry data.Compare client and industry data.2.2. Compare client data with similarCompare client data with similar prior period data.prior period data.3.3. Compare client data withCompare client data with client-determined expected results.client-determined expected results.4.4. Compare client data withCompare client data with auditor-determined expected results.auditor-determined expected results.5.5. Compare client data with expectedCompare client data with expected results, using nonfinancial data.results, using nonfinancial data.

1.1. Compare client and industry data.Compare client and industry data.2.2. Compare client data with similarCompare client data with similar prior period data.prior period data.3.3. Compare client data withCompare client data with client-determined expected results.client-determined expected results.4.4. Compare client data withCompare client data with auditor-determined expected results.auditor-determined expected results.5.5. Compare client data with expectedCompare client data with expected results, using nonfinancial data.results, using nonfinancial data.


Compare Client and Industry DataCompare Client and Industry Data

Inventory turnoverInventory turnover 3.4 3.4 3.5 3.5 3.9 3.9 3.4 3.4Gross marginGross margin 26.3%26.3% 26.4%26.4% 27.3%27.3% 26.2%26.2%

Inventory turnoverInventory turnover 3.4 3.4 3.5 3.5 3.9 3.9 3.4 3.4Gross marginGross margin 26.3%26.3% 26.4%26.4% 27.3%27.3% 26.2%26.2%

ClientClient IndustryIndustry20052005 20042004 20052005 20042004


Compare Client Data with Similar Compare Client Data with Similar Prior Period DataPrior Period Data

Net salesNet sales $143,086$143,086 100100 .0.0 $131,226$131,226 100.0100.0Cost of goods soldCost of goods sold 103,241 103,241 72 72 .1.1 94,876 94,876 72.3 72.3Gross profitGross profit $ 39,845$ 39,845 27.9 27.9 $ 36,350$ 36,350 27.7 27.7Selling expenseSelling expense 14,810 14,810 10 10 .3.3 12,899 12,899 9.8 9.8Administrative expenseAdministrative expense 17,665 17,665 12.4 12.4 16,757 16,757 12.8 12.8OtherOther 1,689 1,689 1 1 .2.2 2,035 2,035 1.6 1.6Earnings before taxesEarnings before taxes $ 5,681$ 5,681 4.0 4.0 $ 4,659$ 4,659 3.5 3.5Income taxesIncome taxes 1,747 1,747 1.2 1.2 1,465 1,465 1.1 1.1Net incomeNet income $ 3,934$ 3,934 2.8 2.8 $ 3,194$ 3,194 2.4 2.4

Net salesNet sales $143,086$143,086 100100 .0.0 $131,226$131,226 100.0100.0Cost of goods soldCost of goods sold 103,241 103,241 72 72 .1.1 94,876 94,876 72.3 72.3Gross profitGross profit $ 39,845$ 39,845 27.9 27.9 $ 36,350$ 36,350 27.7 27.7Selling expenseSelling expense 14,810 14,810 10 10 .3.3 12,899 12,899 9.8 9.8Administrative expenseAdministrative expense 17,665 17,665 12.4 12.4 16,757 16,757 12.8 12.8OtherOther 1,689 1,689 1 1 .2.2 2,035 2,035 1.6 1.6Earnings before taxesEarnings before taxes $ 5,681$ 5,681 4.0 4.0 $ 4,659$ 4,659 3.5 3.5Income taxesIncome taxes 1,747 1,747 1.2 1.2 1,465 1,465 1.1 1.1Net incomeNet income $ 3,934$ 3,934 2.8 2.8 $ 3,194$ 3,194 2.4 2.4

20042004

(000)(000)Prelim.Prelim.

% of% ofNet salesNet sales

20032003

(000)(000)Prelim.Prelim.

% of% ofNet salesNet sales



Compute common financial ratios.Compute common financial ratios.


Common Financial RatiosCommon Financial Ratios

Short-term debt-paying abilityShort-term debt-paying abilityShort-term debt-paying abilityShort-term debt-paying ability

Liquidity activity ratiosLiquidity activity ratiosLiquidity activity ratiosLiquidity activity ratios

Ability to meet long-term debt obligationsAbility to meet long-term debt obligationsAbility to meet long-term debt obligationsAbility to meet long-term debt obligations

Profitability ratiosProfitability ratiosProfitability ratiosProfitability ratios


Short-term Debt-paying AbilityShort-term Debt-paying Ability

Cash ratio:Cash ratio:(Cash + Marketable securities) ÷ Current liabilities(Cash + Marketable securities) ÷ Current liabilities

Cash ratio:Cash ratio:(Cash + Marketable securities) ÷ Current liabilities(Cash + Marketable securities) ÷ Current liabilities

Quick ratio:Quick ratio:(Cash + Marketable securities(Cash + Marketable securities+ Net accounts receivable) ÷ Current liabilities+ Net accounts receivable) ÷ Current liabilities

Quick ratio:Quick ratio:(Cash + Marketable securities(Cash + Marketable securities+ Net accounts receivable) ÷ Current liabilities+ Net accounts receivable) ÷ Current liabilities

Current ratio:Current ratio:Current assets ÷ Current liabilitiesCurrent assets ÷ Current liabilities

Current ratio:Current ratio:Current assets ÷ Current liabilitiesCurrent assets ÷ Current liabilities


Liquidity Activity RatiosLiquidity Activity Ratios

Accounts receivable turnover:Accounts receivable turnover:Net sales ÷ Average gross receivables Net sales ÷ Average gross receivables

Accounts receivable turnover:Accounts receivable turnover:Net sales ÷ Average gross receivables Net sales ÷ Average gross receivables

Days to collect receivables:Days to collect receivables:365 days ÷ Accounts receivable turnover365 days ÷ Accounts receivable turnover

Days to collect receivables:Days to collect receivables:365 days ÷ Accounts receivable turnover365 days ÷ Accounts receivable turnover

Inventory turnover:Inventory turnover:Cost of goods sold ÷ Average inventoryCost of goods sold ÷ Average inventory

Inventory turnover:Inventory turnover:Cost of goods sold ÷ Average inventoryCost of goods sold ÷ Average inventory

Days to sell inventory:Days to sell inventory:365 days ÷ Inventory turnover365 days ÷ Inventory turnover

Days to sell inventory:Days to sell inventory:365 days ÷ Inventory turnover365 days ÷ Inventory turnover


Ability to Meet Long-term Debt Ability to Meet Long-term Debt ObligationObligation

Debt to equity:Debt to equity:Total liabilities ÷ Total equityTotal liabilities ÷ Total equity

Debt to equity:Debt to equity:Total liabilities ÷ Total equityTotal liabilities ÷ Total equity

Times interest earned:Times interest earned:Operating income ÷ Interest expenseOperating income ÷ Interest expense

Times interest earned:Times interest earned:Operating income ÷ Interest expenseOperating income ÷ Interest expense


Profitability RatiosProfitability Ratios

Earnings per share:Earnings per share:Net income ÷ Average common shares outstandingNet income ÷ Average common shares outstanding

Earnings per share:Earnings per share:Net income ÷ Average common shares outstandingNet income ÷ Average common shares outstanding

Gross profit percent:Gross profit percent:(Net sales – Cost of goods sold) ÷ Net sales(Net sales – Cost of goods sold) ÷ Net sales

Gross profit percent:Gross profit percent:(Net sales – Cost of goods sold) ÷ Net sales(Net sales – Cost of goods sold) ÷ Net sales

Profit margin:Profit margin:Operating income ÷ Net salesOperating income ÷ Net sales

Profit margin:Profit margin:Operating income ÷ Net salesOperating income ÷ Net sales


Profitability RatiosProfitability Ratios

Return on assets:Return on assets: Income before taxes ÷ Average total assetsIncome before taxes ÷ Average total assets

Return on assets:Return on assets: Income before taxes ÷ Average total assetsIncome before taxes ÷ Average total assets

Return on common equity:Return on common equity:(Income before taxes – Preferred dividends)(Income before taxes – Preferred dividends)÷ Average stockholders’ equity÷ Average stockholders’ equity

Return on common equity:Return on common equity:(Income before taxes – Preferred dividends)(Income before taxes – Preferred dividends)÷ Average stockholders’ equity÷ Average stockholders’ equity


Summary of Analytical ProceduresSummary of Analytical Procedures

They involve the computation of ratiosThey involve the computation of ratiosand other comparisons of recordedand other comparisons of recordedamounts to auditor expectations.amounts to auditor expectations.

They involve the computation of ratiosThey involve the computation of ratiosand other comparisons of recordedand other comparisons of recordedamounts to auditor expectations.amounts to auditor expectations.

They are used in planning to understandThey are used in planning to understandthe client’s business and industry.the client’s business and industry.

They are used in planning to understandThey are used in planning to understandthe client’s business and industry.the client’s business and industry.

They are used throughout the audit to identifyThey are used throughout the audit to identifypossible misstatements, reduce detailed tests,possible misstatements, reduce detailed tests,and to assess going-concern issues.and to assess going-concern issues.

They are used throughout the audit to identifyThey are used throughout the audit to identifypossible misstatements, reduce detailed tests,possible misstatements, reduce detailed tests,and to assess going-concern issues.and to assess going-concern issues.


End of Chapter 8End of Chapter 8

8 - 1 ©2006 prentice hall business publishing, auditing 11/e, arens/beasley/elder audit planning...

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