Laramie Wire Manufacturing: Using Analytical Procedures in Audit Planning
February 18, 2011
Laramie Wire Manufacturing, a medium sized company, is planning an initial public offering of its stock in the next two to three years. Laramie operates in a single 500,000 square foot building complex. Laramie buys copper rod and plastic materials to produce insulated copper wiring. The building complex is composed of 3% office space, 57% production area, 15% shipping and receiving area, and 25% finished goods and raw materials inventory warehousing area. Laramie produces several different types and gauges of insulated copper wire. All the different products Laramie manufactures use the same raw materials, meaning raw material inventory is stored in one location. Within the storage location insulated copper wire is stored on stackable spools with approximately 500,000 feet of wire per spool. The copper rod inventory is stored on 5 feet tall and 6 feet by 6 feet non stackable pallets that hold 1,500 pounds of copper rod. While plastics inventory is stored in 4 feet tall stackable barrels containing approximately 350 pounds of plastic per barrel.
Laramie is a first time client of the firm, and has hired the firm to perform a financial statement audit to prepare for the initial public offering. The senior auditor has been assigned to auditing inventories in the planning stages of the audit, and must conduct analytical procedures. A quick visual examination of inventories revealed no problems and well organized production areas.
Under the Public Company Accounting Oversight Board there are several auditing standards that apply to the audit of Laramie’s inventory accounts, and the conduct of analytical procedures. AS No. 9, Auditing Planning, is the first standard that applies by stating that, “the planned nature, timing, and extent of tests of controls and substantive procedures….complies with PCAOB standards.” Secondly, AS No. 14, Evaluating Auditing Results states that, “in the audit of financial statements, the auditor’s evaluation of audit results should include evaluation of the results of analytical procedures performed in the overall review of financial statements.” Lastly, AS No. 15, Audit Evidence, gives the audit procedures for obtaining audit evidence which includes substantive analytical procedures. Also, AS No. 15 provides the information that, “analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data.
There are certain auditing standards that pertain to the use of analytical procedures while auditing Laramie’s inventory accounts under the PCAOB. AU 329.08 states, “Although analytical procedures used in planning the audit often use only financial data, sometimes relevant nonfinancial information is considered as well.” This is relevant to Laramie’s case because not only are financial ratios used but nonfinancial information such as, using the square footage of the building complex to assess heightened risk areas within inventory accounts. While AU 329.08 pertains to analytical procedures, AU 331.09 is important for how an independent auditor should examine a client’s inventory accounts. AU 331.09 says that, “it is ordinarily necessary for the independent auditor to be present at the time of count and, by suitable observation, tests, and inquiries, satisfy himself respecting the effectiveness of the methods of inventory-taking.” The auditor usually observes inventory accounts in order to rely on Laramie’s stated condition and quantities of inventory and make a justified opinion.
One analytical procedure that does not use financial data is the amount of square footage Laramie has designated for finished goods and raw inventory in its building complex. After calculating the amount of square footage available for finished goods and raw materials there was a problem with the amount...