Planning the Audit and Analytical Procedures

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Table of Contents

Analytical procedures
Expected amounts for income statement
Estimated effect of misstatement
Materiality
References

Analytical procedures

According to International Standards on Auditing (ISA) 520, analytical procedures entail reviewing the financial information of a company by analyzing the association between financial and non-financial data (Burke, 2009). Carrying out analytical procedures is important because it creates a relationship between the historical financial data of the company and the current information. Thus, an auditor will have a better understanding of the financial statements of the company. It also assists in comparing the results of the company and those of the industry. An auditor needs to perform analytical procedures at the planning stage so as to have a better understanding of the company and its business environment. The procedures facilitate categorizing uncommon transactions or events that may affect the fair view of the company’s financial statements (Public Company Accounting Oversight Board, 2015). Finally, the analytical procedures help an auditor to reduce the risk of possible material misstatement to a low level.

Expected amounts for income statement

Workings

Gross profit for 20×3 = 3,100 / 10,100 * 100 = 30.69%

Gross profit for 20×4 = 30.69 – (100% – 98%) = 30.08%

Gross profit for 20×4 = 30.08% * 10,800 = $3248.55 = $3,099

Depreciation

If the average depreciable assets have increased by 10%, then the depreciation expense will also increase by the same percentage.

= 66 * (100% + 10%) = 72.6 =$73

Interest expense 20×4 = 12% * $2,300,000 = $276,000

Effective tax rate for 20×3

Tax / income before taxes = 50 / 230 * 100 = 21.74%

Tax rate for 20×4 = 21.74% * (100% – 5%) = 20.65%

Uden Supply Company

Income statement.

For the year ended 20×4

	Amount in $000
Sales	10,800
Cost of goods sold	7,701
Gross profit	3,099
Sales commissions	760
Advertising	211
Salaries	1,124
Payroll taxes	207
Employee benefits	188
Rent	63
Depreciation	73
Supplies	32
Utilities	24
Legal and accounting	43
Miscellaneous	15
Interest expense	276
Net income before taxes	83
Income taxes	17
Net income	66

Estimated effect of misstatement

The estimates sales for the year 20×4 are $10,800 thousand. The reported rate of gross profit is 31%. Thus, the resulting gross profit is $3,348. Based on the calculations above, the estimated gross profit is $3,249 thousand. Thus, the effect of the misstatement is that the gross profit is overstated by $99 thousand (Dicksee, 2009). The income before taxes will also be overstated by $77.

Materiality

At the planning stage, it is important to come up with the materiality level of a company. The auditor needs to use both sampling and non-sampling techniques when determining the materiality level of a company. Under-sampling technique, the auditor may use the statistical sampling methods to determine the sample size (Rittenberg, Johnstone, & Gramling, 2012). The auditor then ascertains if the sample selected contains material misstatement (Kumar & Virender, 2006). The results of the sample are used to make an inference about the entire population. In the case of the non-sampling technique, the auditor will use personal judgment to determine the materiality level of the company. It is advisable to use both techniques so as to come up with a comprehensive position on the materiality level (Russell, 2007). Other than estimating the materiality level, an auditor can also the standard threshold of 5%. Thus, omissions or misstatements that fall below this threshold are often considered immaterial. The overstated gross profit ($99 thousand) is equivalent to 42.13% of net profit before tax ($235 thousand). The percentage is greater than 5%. This implies that the misstatement is material.

References

Burke, A. (2009). Introduction to audit planning. Web.

Dicksee, L. (2009). Auditing: a practical manual for auditors. South Carolina: BiblioBazaar.

Kumar, R., & Virender, S. (2006). Auditing: principles and practice. New Delhi: Prentice-Hall of India Private Limited.

Public Company Accounting Oversight Board. (2015). AU section 329A – analytical procedures.Web.

Rittenberg, L., Johnstone, K., & Gramling, A. (2012). Auditing: a business risk approach. Boston: Cengage Learning.

Russell, J. (2007). The internal auditing pocket guide, second edition: preparing, performing, reporting, and follow up. New Mexico: ASQ Quality Press.

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