Analytical Procedures

Definition

Analytical procedures are the processes of evaluating financial information through trend, ratio or reasonableness of data in relation to other financial and non-financial data. In this case, auditors perform data analysis to examine whether it is consistent with other relevant information and whether the fluctuation is within their expectation.

If the auditors identify any irregular fluctuation or find that data relationship is inconsistent with their expectations or other information, they will investigate further on the discrepancy that exists. In this case, the investigation might require them to perform further substantive tests, such as inquiry management about the course of variance and inspecting the supporting document on management’s explanation.

It is also useful to note that analytical procedures are also used in many other non-audit and assurance engagements. For example, cost accountant usually uses analytical procedures to identify the fluctuation of different types of costs or expenses and the reasons behind those fluctuations.

Types of Analytical Procedures

Trend analysis and ratios analysis are the two most commonly used analytical procedures in the audit. Auditors usually use trend and ratio analysis by comparing the amount or balances they obtain from client’s accounts or records to their expectations that were built by using the knowledge obtained in previous years, industry trends, and current economic development, etc.

Trend Analysis

Trend analysis is the process of comparing the data from one period to one or more comparable periods including both comparing to prior period data and comparing to the projections based on the changing patterns in the history data.

Trend analysis may include comparing ratios from one period to another or evaluate the relationship between data, both financial and non-financial, from one period to another.

Ratio Analysis

Ratio analysis is the process of examination of various ratios of the company by comparing them to one or more comparable periods or to other companies in the same industry.

Ratios are usually formed from two or more accounts or balances in the financial statements. In this case, using ratios with trend analysis can help auditors to identify unusual or unexpected changes in relationships between accounts or balances.

Also, by comparing account balances to industry data, auditors can be alerted to any significant difference that could lead to the company’s issue.

For example, if the company has much longer payables days comparing to industry data, it may indicate that the company is having liquidity or cash flow problems. This would alert auditors to question the company about going concern issues.

In summary, analytical procedures may be used in the following forms:

Comparing account balances in the current period to one or more comparable periods
Comparing account balances to the company’s budget and forecasts
Comparing account balances of the company to other companies in the same industry or comparing to the industry average.
Evaluating the relationship of one account balances to other account balances with the predictable pattern
Evaluating the relationship of account balances to non-financial data

Purpose of Analytical Procedures

Auditors perform analytical procedures in various stages of the audit for three main purposes:

To use as risk assessment procedures to obtain an understanding of the client and the risks that the client exposes to
To assess the risks of material misstatements that could occur on the financial statements at the planning stage of the audit
To obtain audit evidence as substantive analytical procedures at the evidence-gathering stage of the audit
To form an overall conclusion whether the financial statements are consistent with auditors’ understanding of the client at the end of the audit

Analytical Procedures in Audit Process

Auditors are required to perform analytical procedures at the planning stage of audit and at the completion stage of audit to perform an overall review of the financial statements before issuing the audit report.

Additionally, analytically procedures may also be used in the evidence-gathering stage in order to obtain sufficient appropriate audit evidence to form an opinion on financial statements.

Analytical Procedures in Audit Process
Analytical Procedures at planning stage	Auditors need to use analytical procedures as risk assessment procedures at the planning stage to obtain an understanding of the client and its business environment. As a result, they may identify the high-risk areas which they are not aware of and assist them in determining the nature, timing, and extent of the audit procedures to address the risks of material misstatements. For example, auditors may use analytical procedures to perform the examination of the relationship between the sales and cost of goods sold by comparing with the prior period or the industry average. This would help them to assess the risks of material error or fraud that could occur on the sale figures in the financial statements. Auditors may also evaluate the relationship between financial information and non-financial information, such as the relationship between sale amount and square footage of selling space.
Analytical Procedures at Evidence Gathering Stage	Auditors have responsibilities to design and perform substantive procedures to gather sufficient appropriate audit evidence in order to form a basis of opinion on financial statements. In this case, substantive procedures may include both the test of details and analytical procedures. Analytical procedures in this stage of audit are usually referred to as substantive analytical procedures. Likewise, in performing substantive analytical procedures, auditors need to consider a number of factors below: Suitability of analytical procedures, e.g. is performing analytical procedures on sale amount can assure the assertion of completeness, accuracy, or cutoff? Also, analytical procedures may not be suitable if the client’s internal controls are weak. Reliability of data used in developing the ratio or expectation, e.g. is the data used from an internal source or external source? Is data comparable, e.g. with industry average? Is the data used relevant? Whether the expectation can identify material misstatements, e.g. the expected gross margin from one period to another give better assurance than the fluctuation of the research and development expenses Whether the difference between the recorded amount and expected value is acceptable, e.g. how much difference in percentage can be acceptable, 3%, 5%, or 10%? Usually, auditors will reduce the acceptable level of difference in order to increase the desired level of assurance if the risk of material misstatement is high.
Analytical Procedures at Completion Stage	Auditors need to perform analytical procedures at the end of the audit after obtaining sufficient appropriate audit evidence to form an overall conclusion whether the client’s financial statements are reasonable and consistent with their understanding. As a result, auditors may identify the risk of material misstatements that they overlooked. In this case, they may need to revise their risk assessment at the planning stage and re-evaluate the planned audit procedures.

Analytical Procedures in Audit Process

Analytical Procedures at planning stage

Auditors need to use analytical procedures as risk assessment procedures at the planning stage to obtain an understanding of the client and its business environment. As a result, they may identify the high-risk areas which they are not aware of and assist them in determining the nature, timing, and extent of the audit procedures to address the risks of material misstatements.

For example, auditors may use analytical procedures to perform the examination of the relationship between the sales and cost of goods sold by comparing with the prior period or the industry average. This would help them to assess the risks of material error or fraud that could occur on the sale figures in the financial statements.

Auditors may also evaluate the relationship between financial information and non-financial information, such as the relationship between sale amount and square footage of selling space.

Analytical Procedures at Evidence Gathering Stage

Auditors have responsibilities to design and perform substantive procedures to gather sufficient appropriate audit evidence in order to form a basis of opinion on financial statements. In this case, substantive procedures may include both the test of details and analytical procedures.

Analytical procedures in this stage of audit are usually referred to as substantive analytical procedures.

Likewise, in performing substantive analytical procedures, auditors need to consider a number of factors below:

Suitability of analytical procedures, e.g. is performing analytical procedures on sale amount can assure the assertion of completeness, accuracy, or cutoff? Also, analytical procedures may not be suitable if the client’s internal controls are weak.

Reliability of data used in developing the ratio or expectation, e.g. is the data used from an internal source or external source? Is data comparable, e.g. with industry average? Is the data used relevant?

Whether the expectation can identify material misstatements, e.g. the expected gross margin from one period to another give better assurance than the fluctuation of the research and development expenses

Whether the difference between the recorded amount and expected value is acceptable, e.g. how much difference in percentage can be acceptable, 3%, 5%, or 10%? Usually, auditors will reduce the acceptable level of difference in order to increase the desired level of assurance if the risk of material misstatement is high.

Analytical Procedures at Completion Stage

Auditors need to perform analytical procedures at the end of the audit after obtaining sufficient appropriate audit evidence to form an overall conclusion whether the client’s financial statements are reasonable and consistent with their understanding.

As a result, auditors may identify the risk of material misstatements that they overlooked. In this case, they may need to revise their risk assessment at the planning stage and re-evaluate the planned audit procedures.

Analytical Procedures

Definition

Types of Analytical Procedures

Purpose of Analytical Procedures

Analytical Procedures in Audit Process

Related posts: