Chapter 4: Section 3

Question 1

What is much of the evidence gathering the auditor does based on?

Answer 1

Verification techniques outlined earlier in the course (AEEIOUR)

Question 2

What is the first verification technique of AEEIOUR, analytical procedures, based on?

Answer 2

The auditor’s ability to interpret financial info

Question 3

What does ISA 315 (Revised) help to identify at the risk assessment stage of the audit as per ISA 315 (Revised): para. 14?

Answer 3

Helps to identify aspects of the entity being audited that the auditor might not have been aware of, using analytical procedures to identify plausible relationships between items of financial and non-financial info

Question 4

Broadly speaking what should not be happening with assets and liabilities?

Answer 4

Assets should not be overstated nor liabilities understated when supported by relevant data (such as revenue or purchases)

Question 5

Give examples of the type of financial and non-financial info relations sought could include? (4)

Answer 5

1. Consistent amounts of nca, working capital and expenditure for a specific level of activity (e.g., consistent receivables and revenues increases)
2. Consistent lengths of time taken to collect debts or pay invoices
3. Consistent amounts of return for a given amount of investment in nca
4. Consistent amounts of debt to equity

Question 6

In the examples given, how is the amount of consistency in all those areas assessed and why?

Answer 6

Over a number of time frames to allow the auditor to pinpoint any specific areas of risk

Question 7

What are the first 8 ratios that can be used to pinpoint any specific areas of risk?

Answer 7

1. ROCE
2. Return on shareholders’ funds
3. Gross profit margin
4. Operating profit margin
5. Expense/revenue percentage
6. Current ratio
7. Quick ratio or ‘acid test’ ratio
8. Inventory turnover

Question 8

What are the last 8 ratios that can be used to pinpoint any specific areas of risk?

Answer 8

9. Inventory holding period (days)
10. Trade receivables collection period (days)
11. Trade payables payment period (days)
12. Working capital cycle (days)
13. Asset turnover (net assets)
14. Asse turnover (NCA)
15. Interest cover
16. Gearing

Question 9

How should gross profit margin and operating profit margin be calculated?

Answer 9

These 2 margins should be calculated in total and by product, area and month/quarter if possible

Question 10

Formula for ROCE.

Answer 10

Operating profit/Capital employed x 100
(Where capital employed = total equity + non-current liabilities)

Question 11

Formula for return on shareholders’ funds.

Answer 11

(Profit after tax/total equity) x 100

Question 12

Formular for gross profit margin

Answer 12

(gross profit/revenue) x 100

Question 13

Formula for operating profit margin

Answer 13

(operating profit/revenue) x 100

Question 14

Formula for expense/revenue percentage

Answer 14

(Specified expense/revenue) x 100

Question 15

Formula for current rati

Answer 15

current asset/current liabilities = x:1

Question 16

Formula for quick ratio or ‘acid test’ ratio

Answer 16

(current assets - inventories)/current liabilities = x:1

Question 17

Formula for inventory turnover

Answer 17

Cost of sales/inventories = x times

Question 18

Formula for inventory holding period (days)

Answer 18

(Inventories/cost of sales) x 365

Question 19

Formula for trade receivables collection period (days)

Answer 19

(trade receivables/revenue) x 365

Question 20

Formula for trade payables payment period (days)

Answer 20

(trade payables/cost of sales) x 365

Question 21

Formula for working capital cycle (days)

Answer 21

Inventory holding period (days) + trade receivables collection period (days) - trade payables payment period (days)

Question 22

Formular for asset turnover (net assets)

Answer 22

revenue/(total assets - current liabs_ = x times

Question 23

Formula for asset turnover (nca)

Answer 23

Revenue/nca = x times

Question 24

Formula for interest cover

Answer 24

Operating profit/finance costs = x times

Question 25

Formula for gearing

Answer 25

Total debt/(total debt + total equity) x 100 (where total debt is all non current liabilities only)

Question 26

Why do ratios mean very little when used in isolation?

Answer 26

Should be calculated for previous periods and for comparable companies

Question 27

What should audit working papers contain in relation to ratios?

Answer 27

Summarised accounts and chosen ratios for prior years

Question 28

In addition to looking at the more usual ratios, what else should the auditor do?

Answer 28

Consider examining other ratios that may be relevant to the particular client's business

Question 29

What are examples of ratios relevant to particular client's business?

Answer 29

E.g., revenue per passenger mile for an airline operator client, or fees per partner for a professional office

Question 30

What is a further important technique auditors can use aside from comparing ratios?

Answer 30

Examine important related accounts in conjunction with each other.

Question 31

Why is it useful for auditors to examine important related accounts in conjunction with each other?

Answer 31

Is often the case that revenue and expense accounts are related to SFP accounts and comparison should be made to ensure that the relationships are reasonable