SAS No. 56, AU 329, ISA 520<br />AU 329 States: <br />“Analytical procedures are an important part of the audit process and consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. Analytical procedures range from simple comparisons to the use of complex models involving many relationships and elements of data.”<br />
Three Purposes of Analytical Procedures<br />Preliminary Analytical Procedures:<br /><ul><li>Helps the auditor better understand the business and assists with the planning of the nature, timing, and extent of audit procedures.</li></ul>Substantive Analytical Procedures: <br /><ul><li>Auditor obtains evidence about account balance or class of transaction assertions. </li></ul>Final Analytical Procedures: <br /><ul><li>provides an overall review of financial information during the final stages of an audit. </li></li></ul><li>Types of Analysis<br />Trend Analysis <br /><ul><li> study of changes over a period of time</li></ul>Ratio Analysis<br /><ul><li>comparison of financial account balances and/or account and nonfinancial data.</li></ul>Reasonableness Analysis <br /><ul><li>creation of an expectation model using financial and non financial data. Model is used to test account balances or changes between periods.</li></li></ul><li>Preliminary Procedures<br />Auditors are required to use the procedures for the planning phase of all audits.<br />Main Objectives<br /><ul><li>understand the business and its transactions
find potential account errors</li></ul>Possible procedures to be used include: account balance comparisons, and important ratios. <br />Inventory Turnover = Cost of Goods Sold/Inventory<br />
Substantive Procedures<br />Step 1: Develop an Expectation<br />Step 2: Define a Tolerable Difference<br />Step 3: Compare the expectations to the recorded amount<br />Step 4: Investigate Differences Greater than the Tolerable Difference<br />
Develop an Expectation<br />Developing an expectation is the most important step in performing analytical procedures.<br />Auditor is required to have an expectation when using analytical procedures.<br />Expectations developed through sources such as:<br /><ul><li>Financial and operating data
Management analysis and Analysts’ reports</li></li></ul><li>Precision of the Expectation<br />Precision: measures the potential effectiveness of a procedure and shows the degree of reliance an auditor can have for a procedure. <br />Precision Factors:<br /><ul><li>Disaggregation
The Plausibility and Predictability of the Relationship Being Studied
Type of Analytical Procedure Used to Form an Expectation</li></li></ul><li>Define a Tolerable Difference<br />The tolerable difference will be based on the significance of the account, the degree of reliance the substantive analytical procedure needed, the level of disaggregation in the amount being tested, and the precision of the expectation<br /><ul><li>For instance, the auditor may use a rule of thumb such as, “tolerable difference is 5 percent of the client’s recorded amount, but not the exceed tolerable misstatement.”</li></li></ul><li>Compare the Expectation to the Recorded Amount<br />The auditor will compare the auditor’s expectation to the recorded amount to determine if the difference exceeds the predetermined “tolerable difference.”<br /><ul><li>If the difference is less than the tolerable difference, the account is accepted.
If the difference is more than the tolerable difference, the auditor must investigate the difference using other audit procedures.</li></li></ul><li>Investigate Differences<br />Quantification<br /><ul><li>Determining whether the explanation or error can explain the observed difference.
This may require the recalculation of the expectation after considering the additional information.</li></ul>Corroboration <br /><ul><li>Obtain sufficient appropriate audit evidence linking the explanation to the difference.</li></ul>Evaluation<br /><ul><li>All analytical procedures results need to be conclusive about the achievement of the desired level of assurance.</li></li></ul><li>Final Analytical Procedures<br />Analytical procedures at the final stage of an audit help the auditor assess and evaluate the conclusions and financial statements.<br />Review the trial balance, financial statements, and footnotes to:<br /><ul><li>Judge the adequacy of the evidence
Determine if any other unusual balances/relationships have not been investigated.</li></li></ul><li>Documentation Requirements<br />When using substantive procedures the auditor should document:<br /><ul><li>The expectation and how it was created
Results of the comparison of the expectation or the ratios.</li></li></ul><li>Nature of the Assertion<br />Substantive procedures can test all transactions and balance assertions EXCEPT rights and obligations.<br />May be more effective at detecting completeness assertions than providing detailed evidence.<br /><ul><li>Some assertions work better with analytical procedures than others
Auditor must ensure the analytical procedures matches the assertion being examined.</li></li></ul><li>Conclusion<br />Preliminary, substantive and final analytical procedures are important in the execution of an audit.<br />By conducting preliminary and substantive procedures, the auditor is able to produce the documentation necessary to prove or disprove the assumptions made for the audit. <br />
Review Questions<br /><ul><li>What are the three types of analytical procedures?