Analytical Procedures in Auditing: What Is It and Why Is It Important

Analytical procedures help an auditor to critically assess if presented financial information has a plausible/logical relationship with other financial and non-financial information.

These procedures are usually performed at the audit’s planning, execution, and finalization stage to assign overall risk to the audit engagement, gain audit evidence, and ensure numbers align with the auditor’s understanding.

For instance, if the auditor notices a massive increase in the accounts receivable and credit sales have significantly declined, there is a logical clash, and the auditor may conclude that there may be a higher risk of overstatement in the accounts receivable.

So, if an auditor has concluded a higher risk in debtors, they need to plan extensive audit procedures to assess if the account balance is free from material misstatement.

Detailed concept

Auditors gather financial and non-financial information from clients/management to understand the business and assess overall risk in the audit engagement.

To understand the business and execute audit, they use several auditing procedures, including observation, inspection, inquiry, external confirmation, recalculation, subsequent testing, and analytical procedures, etc.

Performance of analytical procedures is one of the essential procedures used by auditors to assess the risk of material misstatement in the overall engagement and test accuracy of the account balances. An auditor uses these procedures at the following stages of the audit.

  1. Planning stage (required by International auditing standard 315)
  2. Execution stage
  3. Finalization stage (required by International auditing standard 520)

The use of analytical procedures at the planning stage helps to understand the nature of the business, comparative financial performance, the position of an audit client in comparison to industry, and overall risk in the engagement.

The account balance with plausible movement is considered to have less risk than the counterpart. Further, the purpose of risk estimation at the planning stage is to appropriately allocate time and resources for the performance of audit procedures. So, more time and resources are assigned to the account balance with higher risk and vice versa.

Analytical procedures can also be used at the execution stage of the audit to collect audit evidence if the auditor considers the use of analytical procedures will be more effective than a test of details. In practice, limited assurance is obtained using analytical procedures at the execution stage of the audit.

ISA 520 requires auditors to perform analytical procedures on financial information at the time of audit finalization. The logic to perform a final analytical review is that figures in the financial statement may have changed due to adjustments during the audit.

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So, auditors need to ensure if financial information in the balance sheet is in line with their understanding of the engagement.

Example of Analytical Procedures

Different analytical procedures are performed by auditors depending on the objective of procedure performance. Let’s discuss different aspects of these procedures.

1- Trend analysis

Trend analysis involves collecting different information pertaining to different periods and comparing them with each other. It involves investigating the areas with higher fluctuation if there is some unusual movement in the balance. The main aspects of trend analysis include,

  • Examination of the revenue and cost pattern to assess if there are some significant fluctuations.
  • Study of the sales pattern with respect to product, geography, customers, and regions, etc.
  • Examination of the expense reports finding if there is some evidence of unusual expense.

It’s important to note that trend analysis can be applied to any balance if information pertaining to different accounting periods can be obtained.

2- Ratio analysis

Ratio analysis helps to gain comprehensive insights into the different operating aspects of the business. It’s a comparative and quantitative method that presents analytical insights to find significant balances variations.

Different perspectives of the ratio analysis include profitability, liquidity, gearing, efficiency, market prospect, and turnover, etc.

3- Regression analysis

It’s a technical statistical method of understanding the different variables.

4- Reasonableness testing

This technique involves the assessment of the reasonableness for the events, transactions, and account balances.

Steps to perform audit procedures

There are following four steps inherent in the process of performing analytical procedures,

1- Development of independent expectation

It involves the development of reasonable and concise expectations of the account balance/quantitative output. The expectation is developed on the basis of the auditor’s understanding of the business, market condition, country’s economy, and overall understanding.

2- Define a threshold for a fluctuation to be normal

It involves setting up a certain level of acceptance for the variation. For instance, an auditor may decide if variation in the account balance is 10% or below; it stands for immaterial change.

Furthermore, settings up for the threshold may be different for the different heads depending on their nature and materiality level.

However, the threshold should not exceed planning materiality to ensure auditors collects sufficient and appropriate information on all the risky items.

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3- Computation of the difference in variance

It’s a simple mechanical step where expected values and the recorded values need to be compared. It should be considered normal if the resulting values are under the threshold set in the second stage. However, if the difference is more than the threshold, it should be investigated.

The essential point to note is that the threshold and expectations of the account balance must be calculated before computing this difference, as an outcome of this balance might impact the professional judgment to set expectations and thresholds.

4- Investigation of the variations above the threshold

All the material thresholds must be investigated in full. The best practice is to fully understand why the specific figure is so different from previous periods or the industry average. The auditor should understand and carefully document the logic behind fluctuations in the account balance.

Sometimes, the reason for a higher variance may be some factors that have been overlooked in calculating the expected values. So, things need to be revised if that’s the case.

Why is the performance of analytical procedures essential in an audit?

Performance of analytical procedures is considered essential from the planning stage to the execution and finalization of the audit. Following are some of the crucial aspects of auditing that are assisted by the performance of the analytical procedures.

  1. It helps auditors identify areas with significant risk and gain comprehensive insights into the client’s industry, financial position, financial performance, operational performance, operating weakness in the accounting system, and study balance movement patterns.
  2. The identified risk of material misstatement on the different account balances helps an auditor plan procedures, allocate resources, and set sampling thresholds. It ultimately impacts the expected cost of an audit engagement.
  3. It helps an auditor to get assurance/collect evidence for the risks identified in the planning stage of the audit. In simple words, if the auditor plans to perform analytical procedures at the execution stage, the sample size for the Test of details can be reduced.
  4. Investigation of the variances enables the auditor to deeply understand the movements that have been reported under the current balance sheet of the business. Furthermore, logical linking and study of plausible relations enable an auditor to know their client.
  5. Performance of analytical procedures before finalization helps the auditor ensure the financial statement is in line with their understanding. Further, sufficient and appropriate audit evidence has been collected on all risky balances that enables them to verify the true and fairness of the financial statement reasonably.
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Conclusion

Analytical procedures are used throughout audit engagement, including planning, execution, and reporting. Adequate performance of analytical procedures enables an auditor to perform multiple tasks, including risk identification, setting sample size, drafting audit programs, and collecting audit evidence.

Further, the performance of the analytical procedures enables auditors to get more insights into their audit client; it enables an auditor to understand their market, industry, external economic conditions, and several other factors to plan, conduct and finalized the audit.

Frequently asked questions

What are the different types of audit procedures?

Different types of audit procedures include the following.

  1. Inspection of the documents.
  2. Observation of the facts.
  3. Sending, receiving, and comparing external confirmation to obtain assurance on the account balance.
  4. Inquiry for the critical items.
  5. Performing recalculation on different items like depreciation, and amortization,.
  6. Performing analytical procedures (Comparing numbers and getting insights)

 What is the main theme of performing an analytical procedure?

The basic theme of performing the analytical procedure is to assess if the fluctuation of the account balance is in line with the reasonably expected spectrum developed based on external and internal factors impacting the business performance.

What’s the difference between substantive testing, Test of controls, and analytical procedures?

Mainly substantive testing looks for physical evidence supporting the figures recorded and presented in the financial statement. On the flip side, the Test of control is focused on testing the operating efficiency of the client’s business process system.

Based on control walkthroughs, if an auditor concludes system of designed internal controls is effective on a particular balance, the sample size decreases as partial assurance has already been obtained relying on the tested system of controls.

On the other hand, the analytical procedure compares numbers and develops an assessment if fluctuations are in line with reasonably developed expectations.

What sort of evidence auditor look for?

The auditors are looking for sufficient and appropriate audit evidence. It’s the evidence that enables auditors to issue their opinion on a set of financial statements. If auditors cannot obtain sufficient and appropriate audit evidence, they might report scope limitation/qualification in the audit report depending on the circumstances.

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