In auditing the financial statements of a manufacturing company, the PA has found that the traditional audit trail has been replaced by an electronic one. As a result, the PA may place increased emphasis on automated internal controls and on analytical procedures of the data under audit. These tests, which are also applied in auditing visibly posted accounting records, include the computation of ratios that are compared with prior-year ratios or with industry-wide norms. Examples of analytical procedures are the computation of the rate of inventory turnover and the computation of the number of days’ sales in receivables.
REQUIRED
a. Discuss the advantages to the public accountant of the use of analytical procedures in an audit.
b. In addition to the computations given in part (c), list five ratios that an auditor may compute during an audit on balance sheet accounts and related income accounts. For each ratio listed, name the two (or more) accounts used in its computation.
c. When an auditor discovers that there has been a significant change in a ratio when compared with the preceding year’s, he or she considers the possible reasons for the change. Give the possible reasons for the following significant changes in ratios:
1. The rate of inventory turnover (ratio of cost of sales to average inventory) has decreased from the preceding year’s rate.
2. The number of days’ sales in receivables (ratio of average daily accounts receivable to sales) has increased over the prior year.