Question

Analytical procedures are a critical part of audit work. Describe at least three (3) different analytical procedures and explain how to perform each. Specify what the results will reveal about the client

Answer 1

Analytical procedures are an important part of the audit process and consist of evaluations of financial information made by a study of plausible relationships among both financial and non financial data.

Analytical procedures are also commonly used in non-audit and assurance engagements, such as reviews of prospective financial information, and non-audit reviews of historical financial information. While the use of analytical procedures in such engagements is not covered in the ISAs, the principals regarding their use are relevant.

analytical procedures are as follows:

• Compare the days sales outstanding metric to the amount for prior years. This relationship between receivables and sales should remain about the same over time, unless there have been changes in the customer base, the credit policy of the organization, or its collection practices. This is a form of ratio analysis.

• Review the current ratio over several reporting periods. This comparison of current assets to current liabilities should be about the same over time, unless the entity has altered its policies related to accounts receivable, inventory, or accounts payable. This is a form of ratio analysis.

• Compare the ending balances in the compensation expense account for several years. This amount should rise somewhat with inflation. Unusual spikes may indicate that fraudulent payments are being made to fake employees through the payroll system. This is a form of trend analysis.

• Examine a trend line of bad debt expenses. This amount should vary in relation to sales. If not, management may not be correctly recognizing bad debts in a timely manner. This is a form of trend analysis.

There are several types of analytical procedures commonly used as substantive procedures and will influence the precision of the expectation. The auditor chooses among these procedures based on his objectives for the procedures (ie purpose of the test, desired level of assurance).

• Trend analysis – the analysis of changes in an account over time.
• Ratio analysis – the comparison, across time or to a benchmark, of relationships between financial statement accounts and between an account and non-financial data.
• Reasonableness testing – the analysis of accounts, or changes in accounts between accounting periods, that involves the development of a model to form an expectation based on financial data, non - financial data, or both.