Scope and objectives
The Auditing standard being discussed in the auditors how use analytical procedures during financial statement audits. Analytical procedures refer to the evaluation of financial information by analysing plausible relationships between both financial and non-financial data. This type of analysis helps auditors to obtain relevant and reliable audit evidence when using substantive analytical procedures.
Analytical procedures can also be used as procedures near the end of the audit to assist the auditor in forming an overall conclusion on the financial statements. The auditor’s choice of procedures, methods, and level of application is a matter of professional judgement, and various methods may be used to perform analytical procedures.
SA 520 also provides examples of the types of comparisons and relationships that may be considered when performing analytical procedures. These include comparisons of the entity’s financial information with comparable information for prior periods, anticipated results of the entity, and similar industry information. Relationships may also be considered between elements of financial information that would be expected to conform to a predictable pattern based on the entity’s experience and between financial information and relevant non-financial information.
Finally, SA 520 notes that various methods may be used to perform analytical procedures, ranging from simple comparisons to complex analyses using advanced statistical techniques. Analytical procedures may be applied to consolidated financial statements, components, and individual elements of information. Overall, the use of analytical procedures is an important tool for auditors to obtain relevant and reliable audit evidence and assist in forming an overall conclusion on the financial statements.
Substantive Analytical Procedures
The requirements and considerations that auditors should take into account when designing and performing substantive analytical procedures. Substantive analytical procedures are audit procedures that involve the analysis of data to identify relationships and patterns that are inconsistent with expectations. These procedures can be performed alone or in combination with tests of details, and are used to reduce audit risk at the assertion level to an acceptably low level.
The auditor must use their professional judgment to decide which audit procedures to perform, including whether to use substantive analytical procedures, based on the expected effectiveness and efficiency of the available audit procedures in reducing audit risk. They may inquire with management about the availability and reliability of information needed to apply substantive analytical procedures.
The suitability of particular substantive analytical procedures for given assertions depends on the auditor’s assessment of the risks of material misstatement and tests of details for these assertions. Substantive analytical procedures are generally more applicable to large volumes of transactions that tend to be predictable over time. The auditor must assess the effectiveness of the analytical procedure in detecting misstatements that may cause the financial statements to be materially misstated.
Different types of analytical procedures provide different levels of assurance. The determination of the suitability of particular substantive analytical procedures is influenced by the nature of the assertion and the auditor’s assessment of the risk of material misstatement. Particular substantive analytical procedures may also be considered suitable when tests of details are performed on the same assertion.
SA 520 also provides considerations specific to public sector entities. The relationships between individual financial statement items traditionally considered in the audit of business entities may not always be relevant in the audit of governments or other non-business public sector entities. The reliability of data used for substantive analytical procedures is dependent on the source, comparability, nature, and relevance of the information available, as well as the controls over its preparation. The auditor may consider testing the operating effectiveness of controls over the entity’s preparation of information used in performing substantive analytical procedures.
Evaluation of Whether the Expectation is Sufficiently Precise
The auditors should take into account when evaluating whether an expectation can be developed with sufficient precision to detect a misstatement that could cause the financial statements to be materially misstated. These considerations include:
- The accuracy with which the results of analytical procedures can be predicted. Some items, like gross profit margins, may be more consistent from one period to the next than discretionary expenses like research or advertising.
- The degree to which financial information can be disaggregated. Analytical procedures may be more effective when applied to financial information on individual sections of an operation or components of a diversified entity than when applied to the financial statements of the entity as a whole.
- The availability and reliability of both financial and non-financial information. Auditors should consider whether they have access to the necessary financial and non-financial information, such as budgets, forecasts, and production or sales data, to design and carry out analytical procedures.
- Finally, that the auditors should determine what amount of difference between expected and recorded values would be acceptable without further investigation. This is important because not every discrepancy is significant enough to require additional scrutiny
Amount of Difference of Recorded Amounts from Expected Values that is Acceptable
The concept of materiality, which is a key factor in determining the acceptable amount of difference between recorded amounts and expected values. Materiality refers to the importance or significance of a financial statement item, such as an account balance or transaction, to the overall financial statements. If a misstatement in a material item could influence the decisions of the financial statement users, then it is considered material.
In determining the acceptable amount of difference, auditors need to consider materiality as well as the desired level of assurance. The level of assurance depends on the assessed risk, which refers to the likelihood that the financial statements contain material misstatements. The higher the assessed risk, the more persuasive evidence the auditor needs to obtain to achieve the desired level of assurance.
The acceptable amount of difference that can be tolerated without further investigation decreases as the assessed risk increases. This means that if there is a higher likelihood of material misstatements, auditors need to be more cautious and require more evidence before accepting any differences. This is necessary to achieve the desired level of persuasive evidence and reduce the risk of material misstatements.
Finally, the acceptable amount of difference is also influenced by the possibility that a misstatement, either individually or in combination with other misstatements, could cause the financial statements to be materially misstated. Auditors need to be mindful of this possibility and adjust their procedures accordingly to ensure that they can provide a reliable opinion on the financial statements.
Analytical Procedures that Assist When Forming an Overall Conclusion
The use of analytical procedures by auditors to assist in forming an overall conclusion about whether the financial statements are consistent with their understanding of the entity. These procedures are designed and performed near the end of the audit and are intended to corroborate conclusions formed during the audit of individual components or elements of the financial statements.
The results of these analytical procedures may also identify previously unrecognized risks of material misstatement. In such cases, the auditor must revise their assessment of the risks of material misstatement and modify the planned audit procedures accordingly, in accordance with SA 315.
Furthermore, the analytical procedures performed near the end of the audit may be similar to those used as risk assessment procedures. Overall, these procedures are an important tool for auditors to ensure that they have sufficient evidence to support their opinion on the financial statements.
Investigating Results of Analytical Procedures
The actions of the auditors must take when analytical procedures performed in accordance with the auditing standards reveal fluctuations or relationships that are inconsistent with other relevant information or differ from expected values by a significant amount. In such cases, auditors must investigate these differences by taking the following steps:
(a) Inquiring of management and obtaining appropriate audit evidence relevant to management’s responses: The auditor must ask management to explain the reasons for the inconsistencies or significant differences and obtain relevant audit evidence to support their responses.
(b) Performing other audit procedures as necessary in the circumstances: The auditor may need to perform additional audit procedures beyond the inquiries with management to obtain sufficient evidence to support their opinion on the financial statements.
Audit evidence relevant to management’s responses can be evaluated by taking into account the auditor’s understanding of the entity and its environment, as well as other audit evidence obtained during the course of the audit. This means that the auditor will consider the broader context of the entity’s operations and any other evidence gathered during the audit to assess the credibility of management’s explanations for the discrepancies.
If management is unable to provide a satisfactory explanation for the differences, or the explanation provided is not considered adequate when evaluated in light of other audit evidence obtained, then the auditor must perform additional audit procedures to obtain sufficient evidence to support their opinion on the financial statements.
Overall, these procedures are designed to ensure that the auditor has sufficient evidence to support their opinion on the financial statements and that any significant issues or discrepancies are identified and addressed appropriately.
Analytical Procedures
Analytical procedures are a type of auditing procedure that allow auditors to evaluate financial information and detect potential errors, omissions, or inconsistencies that may indicate risks of material misstatement in the financial statements. There are several types of analytical procedures, as mentioned in the certain objectives.
Trend analysis involves comparing current year information to prior year information and other historical data to identify patterns or fluctuations that are inconsistent with expectations. This can help auditors identify areas of the financial statements that may require further investigation.
Reasonableness tests involve reviewing the relationship of certain account balances to other balances to assess the reasonableness of the amounts reported. For example, auditors may compare the interest expense against interest-bearing obligations to ensure that the interest expense is appropriate relative to the amount of interest-bearing debt outstanding.
Ratios are computed by analysing the relationships between financial statement amounts, such as income or loss as a percentage of sales, gross profit turnover, and inventory turnover. By comparing these ratios to industry benchmarks or prior periods, auditors can identify potential risks of material misstatement.
Quiz: Analytical Procedures
1. Analytical procedures in auditing refer to:
a) Evaluating financial information
b) Assessing internal controls
c) Testing account balances
d) Performing substantive tests
Answer: a)
2. Which of the following is NOT a purpose of analytical procedures in financial statement audits?
a) Obtaining relevant and reliable audit evidence
b) Assisting in forming an overall conclusion
c) Identifying risks of material misstatement
d) Testing internal controls
Answer: d)
3. Analytical procedures can be used:
a) Only at the beginning of an audit
b) Only at the end of an audit
c) Throughout the audit process
d) Only in the planning stage of an audit
Answer: c)
4. Substantive analytical procedures are used to:
a) Test internal controls
b) Detect errors and inconsistencies
c) Assess inherent risk
d) Evaluate management’s assertions
Answer: b)
5. The suitability of particular substantive analytical procedures depends on:
a) The auditor’s professional judgment
b) The size of the entity
c) The complexity of the financial statements
d) The availability of non-financial information
Answer: a)
6. When evaluating whether an expectation can be developed with sufficient precision, auditors should consider:
a) The level of audit risk
b) The accuracy of financial information
c) The availability of non-financial information
d) All of the above
Answer: Answer: d)
7. Materiality refers to the:
a) Overall financial performance of the entity
b) Accuracy of financial statements
c) Importance of a financial statement item
d) Reliability of internal controls
Answer: c)
8. Analytical procedures are generally more applicable to:
a) Non-recurring transactions
b) Predictable transactions
c) Complex transactions
d) High-risk transactions
Answer: Answer: b)
9. When significant differences or inconsistencies are identified through analytical procedures, auditors should:
a) Adjust the financial statements accordingly
b) Ignore them if they are immaterial
c) Investigate and obtain appropriate audit evidence
d) Rely solely on management’s explanations
Answer: c)
10. Analytical procedures performed near the end of the audit can:
a) Replace risk assessment procedures
b) Identify previously unrecognized risks of material misstatement
c) Eliminate the need for substantive tests
d) Validate internal control effectiveness
Answer: b)
Additional question:
11. Which of the following statements is true about analytical procedures?
a) They are only used in the planning stage of an audit.
b) They are performed to test the effectiveness of internal controls.
c) They involve the analysis of financial and non-financial data.
d) They are optional and not required in financial statement audits.
Answer: c)
12. The auditor’s choice of analytical procedures, methods, and level of application is based on:
a) The industry standards for financial statement audits.
b) The auditor’s personal preferences and biases.
c) The size and complexity of the entity being audited.
d) The availability of non-financial information.
Answer: c)
13. Substantive analytical procedures are used to:
a) Assess control risk and inherent risk.
b) Determine the appropriateness of audit procedures.
c) Detect misstatements in the financial statements.
d) Evaluate the entity’s financial performance.
Answer: c)
14. Which of the following factors may influence the reliability of data used for substantive analytical procedures?
a) The source and comparability of the information.
b) The auditor’s personal judgment and biases.
c) The complexity of the financial statements.
d) The size of the entity being audited.
Answer: a)
15. When performing analytical procedures, auditors may compare the entity’s financial information with:
a) Comparable information for future periods.
b) Non-financial information from industry competitors.
c) Prior period information and anticipated results.
d) Financial information from unrelated entities.
Answer: c)
16. The acceptable amount of difference between expected and recorded values without further investigation depends on:
a) The auditor’s personal judgment and biases.
b) The entity’s industry and market conditions.
c) The level of assessed risk and materiality.
d) The availability of non-financial information.
Answer: c)
17. Which of the following is an example of a trend analysis?
a) Comparing revenue to the industry average.
b) Calculating the gross profit margin ratio.
c) Assessing the reasonableness of interest expenses.
d) Analysing the liquidity position of the entity.
Answer: b)
18. The use of analytical procedures near the end of the audit is primarily intended to:
a) Detect fraud and irregularities in financial statements.
b) Identify errors in the entity’s accounting records.
c) Assess the entity’s compliance with regulations.
d) Corroborate conclusions reached during the audit.
Answer: d)
19. Analytical procedures are performed to:
a) Test the accuracy of financial statement disclosures.
b) Verify the completeness of internal control documentation.
c) Evaluate the appropriateness of management estimates.
d) Provide assurance on the entity’s future financial performance.
Answer: c)
20. When significant differences are identified through analytical procedures, auditors should:
a) Ignore them if they are immaterial.
b) Adjust the financial statements accordingly.
c) Obtain additional audit evidence to investigate the differences.
d) Rely solely on management’s explanations.
Answer: c)
Statement on Auditing Standards – SA 210
Statement on Auditing Standards – SA 220
Statement on Auditing Standards – SA 230
Statement on Auditing Standards – SA 240
Statement on Auditing Standards – SA 250
Statement on Auditing Standards – SA 260
Statement on Auditing Standards – SA 265
Statement on Auditing Standards – SA 299
Statement on Auditing Standards – SA 300
Statement on Auditing Standards – SA 315
Statement on Auditing Standards – SA 320
Statement on Auditing Standards – SA 330
Statement on Auditing Standards – SA 402
Statement on Auditing Standards – SA 450
Statement On Auditing Standards – SA 500
Statement on Auditing Standards – SA 501
Statement on Auditing Standards – SA 505
Statement on Auditing Standards – SA 510
Statement on Auditing Standards – SA 520
Statement on Auditing Standards – SA 530
Statement on Auditing Standards – SA 540
Statement on Auditing Standards – SA 560
Statement on Auditing Standards – SA 570
Statement on Auditing Standards – SA 580
Statement on Auditing Standards – SA 600
Statement on Auditing Standards – SA 610
Statement on Auditing Standards – SA 620
Statement on Auditing Standards – SA 700
Statement on Auditing Standards – SA 701
Statement on Auditing Standards – SA 705
Statement on Auditing Standards – SA 706
Statement on Auditing Standards – SA 710
Statement on Auditing Standards – SA 720
Statement on Auditing Standards – SA 800
Statement on Auditing Standards – SA 805
Statement on Auditing Standards – SA 810
Statement on Auditing Standards – SAE 3400
Statement on Auditing Standards – SAE 3402
Statement on Auditing Standards – SRE 2400
Statement on Auditing Standards – SRE 2410
Statement on Auditing Standards – SRS 4400
Statement on Auditing Standards – SRS 4410
