ACCG340 Study Guide - Final Guide: Quick Ratio, Reserve Requirement, Current Liability
19 Jun 2018
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Department
Course
Professor
WK 6
Analytical Procedures – Important for FINAL
1. Analytical procedures’ refer to
evaluation of financial information
through 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 relationships
that are
inconsistent
with 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:
a)
Anticipated results
of the entity,
e.g. budgets, forecasts
b) Comparable info for
prior periods
c)
Similar industry
information
APs also include consideration of
relationships
:
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
formula
Current ratio
Current assets to current liabilities
Quick asset ratio
= Liquid ratio
Liquid assets to current liabilities (only difference:
inventory)
Operating cash ratio
Cash flow from operations to current liabilities
b) Long-term liquidity (solvency)
ratio
formula
Debt equity ratio (the smaller the
better)
Long- and short-term debt to shareholders’ equity
Times interest earned
Net profit to annual interest expense
c) Profitability
ratio
formula
Gross / Net profit ratio
Gross / Net profit to Net sales
Return on total assets
Net profit to Total assets
Return on shareholders’ equity
Net profit to Ordinary shareholders’ equity
d) Activity exam only??
ratio
formula
Receivables turnover *
times/days
Net sales to average accounts receivable
Inventory turnover：*
times/days
Cost of goods sold to average inventory
7. Discussion question
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
1.3
1.9
Liquid ratio – 1.Starting point: <1 à potential CF
difficulty
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 à may experience a CF
difficulty
• The directors propose to recommend a final dividend, which is less than half of the prior
year’s dividend à may experience a CF difficulty
• The company’s gearing ratio (long-term debt/equity capital) has significantly increased
as a result of a $2 million long-term loan which has been entered into in order to finance
a major capital project. The issued capital of $4 million remains unchanged à may experience
a CF difficulty
Required
Discuss the financial position of Getrich Ltd. Support your answer using the above information.
Answer
：
1. Potential overstatement of
inventory
a) Deteriorating inventory turnover and movements in current and liquid ratio (inventory
excluded from liquid ratio) indicate slowing sales of inventory
2. Potential overstatement of
accounts receivable
a) Deteriorating day debtor outstanding indicate debtors taking longer to pay and hence
4. ** compare:
increased CR vs
decreased
LRàinventory
cannot be sold，if
other assets remain
the same!
increased likelihood of doubtful debts
3.
Cash flow
difficulties
a) Deterioration in liquid ratio
b) Need to increased overdraft limit and subsequent breaches of the limit
c) Decrease in dividend payout (potentially indicating decline in profitability as well)
d) Potentially high interest repayments for new loan
8. Substantive analytical procedures (SAPs) – *data, whether the number is reasonable or not
a) Analytical procedures can be used a
substantive procedure in order to anticipate
results.
b) SAPs may be applied to overall financial information. These involve comparison of
current period financial information with:
1) Expected results
2) Prior period information
3) Industry information
4) Predictable pattern information
5) Non-financial information
9. Factors to consider in using SAPs
a)
Suitability
of SAP given the
nature of account/ transaction
and the relevant
assertion
i. consider assessment of the risk of material misstatement & tests of details
b)
Reliability of data
(check if internal control is good or not) from which auditor’s
expectation of recorded amount/ratio is developed
i. source of the information available
ii. comparability of the information available
iii. nature and relevance of information available
iv. controls over the preparation of the information
c)
Preciseness of expectations
i. accuracy of predicted results
ii. level of disaggregation
iii. availability of data
d)
Acceptable difference
between recorded and expected amt (actual vs expected)
i. investigate significant fluctuations/deviations (enquiries of management, other
audit procedures)
10. Analytical procedures when forming overall conclusion - ASA 520.6 &A17-19)
a) Auditor needs to design & perform analytical procedures near END of audit to:
i. Assist in
overall review of reasonableness
of financial report
ii.
Corroborate conclusions
formed during the audit
iii. Ensure financial report is
consistent with auditor’s understanding
of the entity
11. Discussion Question
Develop a substantive analytical procedure to substantiate each of the following balances:
Balance
Substantive analytical procedure
Depreciation
Average
carrying amount of PPE x average depreciation (%)
Document Summary
As risk assessment procedure to obtain an understanding of entity and its environment. Assessing the extent of testing transactions and balances: audit evidence. Assist the auditor when forming an overall conclusion as to whether the financial report is consistent with the auditor"s understanding of the entity: ratios commonly used at the planning stage what variable influence ratio, short-term liquidity ratio formula. Cash flow from operations to current liabilities: long-term liquidity (solvency) ratio formula. Long- and short-term debt to shareholders" equity better) Net profit to annual interest expense: profitability ratio formula. Net profit to ordinary shareholders" equity: activity exam only? ratio formula. Cost of goods sold to average inventory: discussion question. While performing analytical procedures of getrich ltd you noted that a number of ratios had changed significantly since the prior year"s audit: Liquid ratio 1. starting point: <1 potential cf. Inventory turnover 3. problem to sell inventory 63 days.
