Analytical Procedures

Question 1

Analytical Procedures

Answer 1

• evaluations of financial information through analysis of plausible relationships involving both financial and non-financial data

Question 2

When performing analytical procedures you must consider Reliability and you must Annualize:

Answer 2

• Reliability: consider reliability of CY and PY information, consider benchmarks reasonableness, consider if budget is reasonable for the future
• Annualizing: if performing procedures part-way through the year you must annualize statements for comparing purposes ($ / number of months into the year this far x 12 months)

Question 3

Types of analytical procedures

Answer 3

1) horizontal analysis (compare over multiple periods)
2) vertical analysis (item listed as % of total)
3) ratio analysis

Question 4

A/R turnover ratio

Answer 4

• determines how quickly a company is collecting A/R
• A/R decrease indicates risk of uncollectible receivables and risk of inflated A/R
• Procedure: perform receipt testing and connect each payment to A/R GL account

Question 5

Inventory turnover

Answer 5

• indicated how quickly inventory is sold
• decrease indicates risk of old inventory and not worth cost and therefore over stated balance
• Procedure: observe physical inventory and inspect inventory listing to connect the physical to the listing and write down if needed

Question 6

Current ratio

Answer 6

• determine the current assets to current liabilities ratio
• decrease would be going concern issue as the company would not be able to cover debt
• Procedure: analyze cash flow projections and confirm reasonability of inputs

Question 7

Debt to equity ratio

Answer 7

• measure solvency
• increase = going concern issue, decrease = risk that debt is understated
• analyze the debt accounts and inspect documents related to debts

Question 8

GP Margin

Answer 8

• GP / $ of sales available for overhead costs
• increased would mean risk of overstated revenue and understated COGS
• Procedure: collect receipts for sample of sales and confirm completeness

Question 9

Approach in FS analysis (in a case)

Answer 9

1) set expectations (if a company had increased competition and also increased sales this would not match the expectation and would be investigated)
2) compute ratios (you need a benchmark for the ratios - ether PY or market)
3) perform horizontal (PY) and vertical analysis (%) (normally on IS accounts, however, note to compare the IS accounts that relate to BS accounts such as Dep exp. to PPE)
4) Interpret the results (discuss if expectation met, and address what accounts are at RMM and procedures to address such risk)