Analytical Procedures in Auditing

What are analytical procedures as it relates to Auditing? With the help of the International standard of Auditing, we are able to arrive at a uniform definition. According to the International Standards for Auditing 520, Analytical procedures mean evaluations of financial information made by the study of plausible relationships among financial and non-financial data. The procedures also encompass the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted results.

Analytical procedures are special substantive tests performed by auditors to deduce the reasonableness of figures in a client’s financial statements. Analytical procedures involve the following process:

Review of the relationship between one financial data and another: Here the auditor matches financial data obtained from different sources in order to depict the true financial standing of the company in that particular matter. Here the auditor takes into consideration the source of financial information derived thereof, comparability between the different sources of information, relevance of information available and controls over preparation.
Review of relationship between financial and non-financial data. Here the auditor compares financial and non-financial data in order to arrive at a conclusion on the truth and fairness of the particular line of item in the accounts. An example is the relationship of payroll costs to the number of employees or the relationship between budgets or forecasts and number of units produced or sold;
Performing investigations on the occurrence of material variations between budgeted and actual performances. Here the auditor performs a variance analysis by taking into account, the amount of differences between budgeted performances or results, and actual results acceptable without further investigation. This helps the auditor identify unusual transactions or events, amount, trends and ratios which might have been materially misstated either by error or fraud.
Obtaining persuasive evidence from the client’s management to explain material variations. The auditor requests evidence and explanations as to the material variation between budgeted results and actual results.

Analytical procedure tests can be simple or complex depending on the need of the auditor. A simple technique used includes the ratio analysis. Complex analytical procedures on the other hand include the computer audit software and advanced statistical methods such as multiple regression analysis.

Objectives of Analytical Procedures

Analytical procedures in audit help with the following:

It enables the auditor identify areas of potential risk: Remember the variance analysis mentioned above? The auditor after carrying out the variance analysis and noticing any high material misstatement (variance) in the transaction can flag it as a potential risk item for more audit procedures to be performed ;
It enables the auditor understand client’s business. Of course, the auditor gathers audit evidence right from the commencement of the audit. And then performs analytical procedures later on to compare evidence gathered with the expectations developed by the auditor. In doing this, the auditor grows specialist knowledge of the business.
It assists the auditor in identifying critical areas of the audit;
Assists in identifying areas that need further test. As mentioned earlier, the auditor carries out analytical procedures by comparing actual value of transactions with his own expectations or budgeted expectations . If the auditor
Assist the auditor carry out an overall review of the Financial Statement: Carrying out an analytical procedure might assist the auditor in identifying a previously unrecognized risk of material misstatement

Recommended Reading

O. Ray Whitting.,Wiley CPAexcel Exam Review: Auditing and Attesting