As we have seen auditors, are required to carry out
procedures designed to obtain sufficient appropriate audit evidence to
determine with reasonable confidence whether the financial statements are free
of material misstatement. They are also
procedures designed to obtain sufficient appropriate audit evidence to
determine with reasonable confidence whether the financial statements are free
of material misstatement. They are also
required to evaluate the overall
presentation of the financial statements, in other to ascertain whether they
have been prepared in accordance with the relevant legislation and accounting
standards. The auditors have to give an opinion on whether the accounts give a
true and fair view and comply with regulations.
One of the key ways of gathering such evidence is
the use of analytical procedures at each stage of the audit.
the use of analytical procedures at each stage of the audit.
There is the standard ISA 520 ‘analytical
procedures’. This standard requires that auditors should apply analytical
procedures at the planning and overall review stages of the audit.
procedures’. This standard requires that auditors should apply analytical
procedures at the planning and overall review stages of the audit.
It also suggest that analytical procedures can be
applied as substantive procedures designed to obtain audit evidence directly.
applied as substantive procedures designed to obtain audit evidence directly.
Definition
Analytical procedures can be defined as:
The study of plausible relationships between
elements of financial information expected to confirm to a predicable pattern
based on the organization’s experience and between financial information and
non-financial information is compared with comparable information for a prior
period or periods with anticipated results and with information relating to
similar organizations.
elements of financial information expected to confirm to a predicable pattern
based on the organization’s experience and between financial information and
non-financial information is compared with comparable information for a prior
period or periods with anticipated results and with information relating to
similar organizations.
In addition, analytical procedures involved:
·
Investigating
unexpected variations identified by the use of analytical procedures.
Investigating
unexpected variations identified by the use of analytical procedures.
·
Obtaining
and substantiating explanations for such variations
Obtaining
and substantiating explanations for such variations
·
Evaluating
the results of an analytical review with other audit evidence obtained
Evaluating
the results of an analytical review with other audit evidence obtained
In an actual case the procedures might involve:
·
Increases
in magnitude corresponding to inflammation or in excess of inflammation;
Increases
in magnitude corresponding to inflammation or in excess of inflammation;
·
Changes
in amount arising from changes in output levels;
Changes
in amount arising from changes in output levels;
·
Trends
and ratios;
Trends
and ratios;
·
Comparisons
with budgets and forecast;
Comparisons
with budgets and forecast;
·
Comparisons
with other, similar, organizations, e.g. by inter-firm comparison.
Comparisons
with other, similar, organizations, e.g. by inter-firm comparison.
Similar techniques are also applied by management,
investment analysts and internal auditors to provide information on the
performance of an entity, the efficiency of its operations or the quality of
its management. Remember that, in performing these procedures, an auditor has a
quite different purpose.
investment analysts and internal auditors to provide information on the
performance of an entity, the efficiency of its operations or the quality of
its management. Remember that, in performing these procedures, an auditor has a
quite different purpose.
Analytical procedures can be simple tests comparing
absolute magnitude of different years, comparing ratios with earlier years,
budgets and industry averages but also:
absolute magnitude of different years, comparing ratios with earlier years,
budgets and industry averages but also:
·
Using
computer audit software;
Using
computer audit software;
·
Using
advanced statistic techniques, e.g. multiple regression analysis.
Using
advanced statistic techniques, e.g. multiple regression analysis.
Timing
Analytical procedures will be applied throughout
the audit but specific occasions include:
the audit but specific occasions include:
·
At the
planning stage. The auditors will hope to identify areas of potential risk or
new developments so that they can plan their other audit procedures in these
areas. As a simple example, the auditors might discover that the gross profit
ratio in a retail organization had changed from the 28-30 per cent of previous
years to 24 per cent. Or they might discover that a sales analysis revealed
that exports had increased from 3 per cent to 26 per- cent of turnover. This
will lead to a direction of the emphasis of audit testing in order to
investigate these apparent anomalies.
At the
planning stage. The auditors will hope to identify areas of potential risk or
new developments so that they can plan their other audit procedures in these
areas. As a simple example, the auditors might discover that the gross profit
ratio in a retail organization had changed from the 28-30 per cent of previous
years to 24 per cent. Or they might discover that a sales analysis revealed
that exports had increased from 3 per cent to 26 per- cent of turnover. This
will lead to a direction of the emphasis of audit testing in order to
investigate these apparent anomalies.
·
During
the audit as a form of gathering audit evidence. Audit with their emphasis on
efficiency and economy depend heavily on analytical procedures as a valid audit
technique either used alon or in conjunction with internal control reliance and
substantive testing.
During
the audit as a form of gathering audit evidence. Audit with their emphasis on
efficiency and economy depend heavily on analytical procedures as a valid audit
technique either used alon or in conjunction with internal control reliance and
substantive testing.
It can be as reasonable to obtain assurance of the completeness,
accuracy and validity of the transactions and balances by analytical procedures
as by other types of audit evidence. For example, if the relative amounts under
different expense headings repeat the pattern of previous years the auditor has
evidence of the accuracy of expense invoice coding.
accuracy and validity of the transactions and balances by analytical procedures
as by other types of audit evidence. For example, if the relative amounts under
different expense headings repeat the pattern of previous years the auditor has
evidence of the accuracy of expense invoice coding.
·
At the
final review stage of the audit. Analytical procedures can provide support for
the conclusions arrived at as a result of other work. The techniques are also
used to assess the overall reasonableness of the financial statements as a
whole.
At the
final review stage of the audit. Analytical procedures can provide support for
the conclusions arrived at as a result of other work. The techniques are also
used to assess the overall reasonableness of the financial statements as a
whole.
Extent of use
Factors which might influence the extent of use of
analytical review include:
analytical review include:
·
The
nature of the entity and its operations. A long-established manufacturing
company which has changed little in the period under review will offer many
opportunities for analytical procedures to be used as a primary source of audit
evidence. Conversely a newly established manufacturer of high-tech products
will not.
The
nature of the entity and its operations. A long-established manufacturing
company which has changed little in the period under review will offer many
opportunities for analytical procedures to be used as a primary source of audit
evidence. Conversely a newly established manufacturer of high-tech products
will not.
·
Knowledge
gained in previous audits of the enterprise. The auditors will have experience of
those areas where errors and difficulties arose and of those areas of greatest
audit risk.
Knowledge
gained in previous audits of the enterprise. The auditors will have experience of
those areas where errors and difficulties arose and of those areas of greatest
audit risk.
·
Managements
own use of analytical procedures. If management has a reliable system of
budgetary control then the auditors will have a ready made source of
explanation for variances. Also the reliability of information subject to
internal audit will be an example of reliable information.
Managements
own use of analytical procedures. If management has a reliable system of
budgetary control then the auditors will have a ready made source of
explanation for variances. Also the reliability of information subject to
internal audit will be an example of reliable information.
·
Availability
of non-financial information to back up financial information. Many companies
record non-financial statistics (e.g. on production, input mixes, etc.). some companies have to make returns of output
(e.g. newspaper on circulation, dairies on gallonage, etc.). all this can be
used as evidence by auditors.
Availability
of non-financial information to back up financial information. Many companies
record non-financial statistics (e.g. on production, input mixes, etc.). some companies have to make returns of output
(e.g. newspaper on circulation, dairies on gallonage, etc.). all this can be
used as evidence by auditors.
·
The
reliability, relevance and comparability of the information available. Clients
that take part in inter-firm comparison exercises will be especially
appropriate for analytical review evidence.
The
reliability, relevance and comparability of the information available. Clients
that take part in inter-firm comparison exercises will be especially
appropriate for analytical review evidence.
·
The
cost-effectiveness of the use of analytical procedures in relation to other
forms of evidence. In general using analytical procedures is cheap but requires
high-quality (and therefore expensive) staff. Some analytical procedures can be
relatively expensive if for example they involve complex statistical techniques
(e.g. multiple regression) and computer audit software where experienced or
specialized staff are required.
The
cost-effectiveness of the use of analytical procedures in relation to other
forms of evidence. In general using analytical procedures is cheap but requires
high-quality (and therefore expensive) staff. Some analytical procedures can be
relatively expensive if for example they involve complex statistical techniques
(e.g. multiple regression) and computer audit software where experienced or
specialized staff are required.
Procedures
The following points can be made:
·
Analytical
review procedures can be best be carried out on partial segments of the
organization, e.g. the branch at Walsall or the paint division or the
subsidiary in France. They can also be used on individual account areas such as
creditors or fixed asset depreciation.
Analytical
review procedures can be best be carried out on partial segments of the
organization, e.g. the branch at Walsall or the paint division or the
subsidiary in France. They can also be used on individual account areas such as
creditors or fixed asset depreciation.
·
Analytical
procedures are a breaking down of data into subdivision for analysis over time,
by product, by location, by management responsibility, etc.
Analytical
procedures are a breaking down of data into subdivision for analysis over time,
by product, by location, by management responsibility, etc.
·
Analytical
procedures are not effective in reviewing an entity as a whole unless it is
very small. The greater the disaggregation the better.
Analytical
procedures are not effective in reviewing an entity as a whole unless it is
very small. The greater the disaggregation the better.
·
One
approach is to identify the factors likely to have an effect on items in the
accounts; to ascertain or assess the probable relationship with these factors
and items; and then to predict the value of the items in the light of the
factors. The predicted value of the items can then be compared with the actual
recorded amounts. As an example, gas consumption is a function of temperature.
A knowledge of daily temperature will permit the auditors to estimate gas
consumption. Factual consumption is similar to that expected the has evidence
of the correctness of the sales value of gas.
One
approach is to identify the factors likely to have an effect on items in the
accounts; to ascertain or assess the probable relationship with these factors
and items; and then to predict the value of the items in the light of the
factors. The predicted value of the items can then be compared with the actual
recorded amounts. As an example, gas consumption is a function of temperature.
A knowledge of daily temperature will permit the auditors to estimate gas
consumption. Factual consumption is similar to that expected the has evidence
of the correctness of the sales value of gas.
·
The
auditors should consider the implications of significant fluctuations, unusual
items or relationships that are unexpected or inconsistent with evidence from
other sources. Similarly they should consider the implications of predicted
fluctuations that fail to occur.
The
auditors should consider the implications of significant fluctuations, unusual
items or relationships that are unexpected or inconsistent with evidence from
other sources. Similarly they should consider the implications of predicted
fluctuations that fail to occur.
·
Any
significant variations should be discussed with management. Independent
evidence must then be sought to validate management’s explanations.
Any
significant variations should be discussed with management. Independent
evidence must then be sought to validate management’s explanations.
·
The
auditor’s reactions should to significant fluctuations or unexpected values
will vary according to the stage of the audit:
The
auditor’s reactions should to significant fluctuations or unexpected values
will vary according to the stage of the audit:
Ø At the planning stage, the auditor will plan suitable
tests;
tests;
Ø At the testing stage of the audit, further test and
other techniques will be indicated;
other techniques will be indicated;
Ø At the final stage the unexpected should not
happen!
happen!
·
All
fluctuations and unexpected values must be fully investigated and sufficient
appropriate audit evidence obtained.
All
fluctuations and unexpected values must be fully investigated and sufficient
appropriate audit evidence obtained.
·
As with
all audit work, analytical procedures should be fully documented in the working
papers. The files should include:
As with
all audit work, analytical procedures should be fully documented in the working
papers. The files should include:
Ø The information examined, the source of that
information and the factors considered in establishing the reliability of the
information;
information and the factors considered in establishing the reliability of the
information;
Ø The extent and nature of material variation found;
Ø The source and level of management from which
explanations were sought and obtained;
explanations were sought and obtained;
Ø The verification of those explanations;
Ø Any further action taken, e.g. further audit
testing;
testing;
Ø The conclusions drawn by the auditors.