(a) Analytical procedures

(i) Analytical procedures mean the study of trends and ratios in financial and non-financial
information.It is used within audit planning to identify risk areas and also as a means of
gathering substantive evidence, for example by calculating an estimate of a particular figure
based on knowledge of thebusiness and comparing this to the actual figure.
(ii) A comparison of gross profit percentages month by month for BearsWorld could be
performed andany unusual fluctuations investigated as these could indicate errors such as
omission of sales, lossof inventory or other errors.
Inquiry
(i)Inquiry means requesting information. This could be from individuals within the company,
either orally or in written representations, or in formal written requests to third parties.
(ii) In BearsWorld a relevant example would be to send a standard confirmation letter to the
company's bank (could be illustrated with an example of enquiry to client staff).
Inspection
(i)Inspection means looking at documentation, books and records or assets. This could be done
to confirm existence of an asset, to verify values or to provide evidence that a control has taken
place.
(ii) The inventory of cuddly toys at the year-end could be inspected as part of the evidence
relating to its value. The inspection would give evidence as to whether the inventory was in good
saleable condition(could be illustrated with an example of inspection of documentation).
Observation
(i)Observation means watching a procedure being carried out. It is usually used as a means of
gathering evidence about the internal controls in a company.
(ii) In BearsWorld it might be appropriate to observe the procedures that are carried out when the
post is opened to assess whether controls exist to prevent the misappropriation of cash.
Recalculation
(i)Recalculation means the reperformance of an arithmetical process within the accounting
system. This could involve re-checking a manual calculation or using a computer-assisted audit
technique to reperform casts within the accounting records.
(ii) Depreciation is likely to be a significant expense within a manufacturing company such as
BearsWorld. The auditor should recalculate this expense
(b) The usefulness of analytical procedures depends on a number of factors including the
reliability of the underlying information. It seems that, as a small business, BearsWorld has little
segregation of duties and formal controls. This casts doubt on the reliability of the information
and hence the conclusions that might be drawn from the analytical procedures.
Inquiry evidence from third parties will be essential in the audit of BearsWorld. As well as the
bank confirmation it may be necessary to send confirmation letters to suppliers to obtain third
party evidence of the liabilities at the year-end. Inquiry evidence from sources within
BearsWorld will be obtained mainly from Mr Kyto and its reliability will be very dependent on
how the auditors assess his integrity.
Inspection of documents will be a major part of the evidence gathered in the audit of
BearsWorld. Supplier invoices will be inspected to verify values and to confirm that purchases
and expenses are genuinely business items. There may be limits to the reliance that can be put on
this as in a poor control environment it may be difficult to confirm whether documentation is
complete.
Observation may be the only way to gather evidence about controls such as any that may exist
over the opening of post. This type of evidence is limited in its usefulness for two reasons:
It only provides evidence that the control operated at the point in time that the auditor carried
out the test.
Client staff are likely to perform their duties exactly according to the company's procedures
manual when they are aware that the external auditor is observing them whereas this may not be
the case on any other day of the year.
To place reliance on controls and reduce substantive testing the auditor needs evidence that
controls operated effectively over the whole of the accounting period so the observation would
be of limited usefulness. Observation of controls in operation over the year-end inventory count
might be more useful as this is a one-off, rather than daily, procedure. If the auditor could see
that the inventory count was being carried out in a well-controlled way then it may be possible to
reduce substantive testing on the inventory sheets.
Re-calculation is a good check of the accuracy of invoices and control accounts. However it
only covers figures that that have been recorded in the accounts, and will not identify omitted
figures.
(с) The following five internal control challenges are some of the most common found in small
businesses.
1. Separation of duties
2. Policies and procedures
3. Documentation
4. Oversight and review
5. User access rights for information systems