WK 6 Analytical Procedures - Important for FINAL 1. Analytical procedures' refer to evaluation of financial informationthrough analysis of plausible relationships among both f inancial & non-financial data 2. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationshipsthat are inconsistentwith other relevant information or that differ from expected values by a significant amount (ASA 520.4) 3. Analytical procedures may therefore assist in identifying the existence of unusual matters that have financial report / audit implications i.e. risk of misstatement 4. Nature of analytical procedures (APs) - ASA520.A1 & A2 APs include consideration of comparisons of entity's financial information with: relationships: APs also include consideration of a) Anticipated results of the entity, e.g. budgets, forecasts b) Comparable info for prior periods c) Similar industry information a) among elements of financial information expected to conform to a predicted pattern, e.g. gross margin percentage b) between financial information & relevant non-financial information e.g. payroll costs to number of employees 5. Purpose of analytical procedures a) Planning i. As risk assessment procedure to obtain an understanding of entity and its environment ii. Identifying areas of potential risk iii. Assessing the extent of testing transactions and balances b) audit evidence i. As substantive procedure (efficient/effective) c) opinion formation i. Assist the auditor when forming an overall conclusion as to whether the financial report is consistent with the auditor's understanding of the entity 6. Ratios commonly used at the planning stage what variable influence ratio a) Short-term liquidity ratio Current ratio Quick asset ratio = Liquid ratio Operating cash ratio Cash flow from operations to current liabilities formula Current assets to current liabilities Liquid assets to current liabilities (only difference: inventory)
b) Long-term liquidity (solvency) ratio Debt equity ratio (the smaller the better) Times interest earned c) Profitability ratio Gross / Net profit ratio Return on total assets Return on shareholders' equity d) Activity exam only ?? ratio Receivables turnover * times/days Inventory turnover: ‘ times/days 7. Discussion question formula Long- and short-term debt to shareholders' equity Net profit to annual interest expense formula Gross / Net profit to Net sales Net profit to Total assets Net profit to Ordinary shareholders' equity formula Net sales to average accounts receivable Cost of goods sold to average inventory While performing analytical procedures of Getrich Ltd you noted that a number of ratios had changed significantly since the prior year's audit : 2013 2014 Current ratio Liquid ratio - 1. Starting point: < 1 > potential CF difficulty 4. ** compare: increased CR vs decreased LR->inventory cannot be sold, if other assets remain 1.3 1.9 0.8 0.6 Days debtors outstanding - 2. A/R - less like to be paid 40 days 54 days Inventory turnover - 3. problem to sell inventory 63 days 118 days You are also aware of the following information: . The company has doubled their overdraft limit (= limit for negative bank balance. ) The limit had been exceeded on a number of occasions during the year > may experience