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Analytical procedures are an important and powerful tool for auditors explaining the performance of a business. ISAs 315 and 320 require the auditors to apply analytical procedures at the planning and overall review stages of the audit.
Required
(a) Explain the possible reasons for the following changes in accounting ratios found at the planning stage of the audit:
(i) an increase in the current ratio;
(ii) a decrease in the gross profit margin; and
(iii) an increase in the inventory holding period.
(b) Explain what automated tools and techniques are and describe how they can be used at the planning stage of the audit.
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Your audit and assurance firm has just accepted a financial statement audit engagement from Meal Haven Ltd, a restaurant that prepares lunch for the general public and on special orders. The company operates at a number of sales points in the city.
The company uses a computerised system that has networked all the sales points to its head office. Your firm is planning the new audit and has received the draft financial statements for the year. As the audit senior to lead the engagement team, you are examining the financial statements, an extract of which is shown below:
Statement of Profit or Loss (Extract)
| Draft 2015 | Audited 2014 | |
|---|---|---|
| GH¢’000 | GH¢’000 | |
| Revenue | 16,346 | 11,300 |
| Cost of Sales | 12,912 | 8,596 |
| Gross Profit | 3,434 | 2,704 |
| Net Profit | 1,962 | 1,130 |
Statement of Financial Position (Extract)
| Draft 2015 | Audited 2014 | |
|---|---|---|
| Non-current Assets | 5,598 | 5,232 |
| Other Current Assets | 3,492 | 2,254 |
| Accounts Receivable | 3,964 | 2,872 |
| Inventories | 1,291 | 860 |
| Accounts Payable | 1,028 | 920 |
Required:
(a) Using analytical procedures at the planning stage, state your observations drawn from the extracts from the draft financial statements and how they may impact on your audit of accounts receivable.
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You have been presented with the following draft financial information about Fresca Solutions, a very successful company that develops and licenses specialist computer software and hardware. Its non-current assets mainly consist of property, computer hardware and investments, and there have been additions to these during the year. The company is experiencing increasing competition from rival companies, most of which specialise in hardware or software, but not both. There is pressure to advertise and cut prices.
You are the audit manager. You are planning the audit and are conducting a preliminary analytical review and associated risk analysis for this client for the year ended 31 May 20X8. You have been provided with a summarised draft statement of comprehensive income which has been produced very quickly and certain accounting ratios and percentages. You have been informed that the company accounts for research and development costs in accordance with IAS 38 Intangible Assets.
Statement of comprehensive income
| Year ended 31 May | ||
|---|---|---|
| 20X7 | 20X8 | |
| €’000 | €’000 | |
| Revenue | 15,206 | 13,524 |
| Cost of sales | 3,009 | 3,007 |
| Gross profit | 12,197 | 10,517 |
| Distribution costs | 3,006 | 1,996 |
| Administration expenses | 994 | 1,768 |
| Selling expenses | 3,002 | 274 |
| Profit from operations | 5,195 | 6,479 |
| Net interest receivable | 995 | 395 |
| Profit before tax | 6,190 | 6,874 |
| Income tax expense | 3,104 | 1,452 |
| Net profit | 3,086 | 5,422 |
| Retained profits | 1,617 | 3,983 |
| Dividends paid | €1,469,000 | €1,439,000 |
Accounting ratios and percentages
| Year ended 31 May | ||
|---|---|---|
| 20X7 | 20X8 | |
| Earnings per share | 0.43 | 1.04 |
| Performance ratios include the following: | ||
| Gross margin | 0.80 | 0.78 |
| Expenses as a percentage of revenue: | ||
| Distribution costs | 0.20 | 0.15 |
| Administrative expenses | 0.07 | 0.13 |
| Selling expenses | 0.20 | 0.02 |
| Operating profit | 0.34 | 0.48 |
Required
(a) In accordance with ISA 520 Analytical Procedures explain when analytical procedures shall or may be carried out and the nature of such procedures.
(b) Using the information above, comment briefly on the performance of the company for the two years.
(c) Use your answer for part (b) to identify the areas that are subject to increased audit risk and describe the further audit work you would perform in response to those risks.
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