What are the three types of analytical procedures?

Analytical procedures are the processes of evaluating financial information through trend, ratio or reasonableness of data in relation to other financial and non-financial data. In this case, auditors perform data analysis to examine whether it is consistent with other relevant information and whether the fluctuation is within their expectation.

If the auditors identify any irregular fluctuation or find that data relationship is inconsistent with their expectations or other information, they will investigate further on the discrepancy that exists. In this case, the investigation might require them to perform further substantive tests, such as inquiry management about the course of variance and inspecting the supporting document on management’s explanation.

It is also useful to note that analytical procedures are also used in many other non-audit and assurance engagements. For example, cost accountant usually uses analytical procedures to identify the fluctuation of different types of costs or expenses and the reasons behind those fluctuations.

Types of Analytical Procedures

Trend analysis and ratios analysis are the two most commonly used analytical procedures in the audit. Auditors usually use trend and ratio analysis by comparing the amount or balances they obtain from client’s accounts or records to their expectations that were built by using the knowledge obtained in previous years, industry trends, and current economic development, etc.

Trend Analysis

Trend analysis is the process of comparing the data from one period to one or more comparable periods including both comparing to prior period data and comparing to the projections based on the changing patterns in the history data.

Trend analysis may include comparing ratios from one period to another or evaluate the relationship between data, both financial and non-financial, from one period to another.

Ratio Analysis

Ratio analysis is the process of examination of various ratios of the company by comparing them to one or more comparable periods or to other companies in the same industry.

Ratios are usually formed from two or more accounts or balances in the financial statements. In this case, using ratios with trend analysis can help auditors to identify unusual or unexpected changes in relationships between accounts or balances.

Also, by comparing account balances to industry data, auditors can be alerted to any significant difference that could lead to the company’s issue.

For example, if the company has much longer payables days comparing to industry data, it may indicate that the company is having liquidity or cash flow problems. This would alert auditors to question the company about going concern issues.

In summary, analytical procedures may be used in the following forms:

• Comparing account balances in the current period to one or more comparable periods
• Comparing account balances to the company’s budget and forecasts
• Comparing account balances of the company to other companies in the same industry or comparing to the industry average.
• Evaluating the relationship of one account balances to other account balances with the predictable pattern
• Evaluating the relationship of account balances to non-financial data

Purpose of Analytical Procedures

Auditors perform analytical procedures in various stages of the audit for three main purposes:

• To use as risk assessment procedures to obtain an understanding of the client and the risks that the client exposes to
• To assess the risks of material misstatements that could occur on the financial statements at the planning stage of the audit
• To obtain audit evidence as substantive analytical procedures at the evidence-gathering stage of the audit
• To form an overall conclusion whether the financial statements are consistent with auditors’ understanding of the client at the end of the audit

Analytical Procedures in Audit Process

Auditors are required to perform analytical procedures at the planning stage of audit and at the completion stage of audit to perform an overall review of the financial statements before issuing the audit report.

Additionally, analytically procedures may also be used in the evidence-gathering stage in order to obtain sufficient appropriate audit evidence to form an opinion on financial statements.

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Analytical procedures are of extreme importance to an auditor.  Firstly, they are required procedures under Canadian Auditing Standards (CAS). Secondly, they can help an audit be both more efficient and effective when compared to test of details such as sampling. The principal CAS standard that provides guidance on the nature and use of analytical procedures is CAS 520 Analytical Procedures. CAS 520.4 defines analytical procedures as:

Evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.

There are various methods that may be used to perform analytical procedures. The methods range from performing simple year over year comparisons of balances, transaction streams or ratios to performing complex analyses using advanced statistical techniques. The level of audit evidence obtained from analytical procedures is directly tied to their sophistication.  In other words, the more complete the analysis the more persuasive the audit evidence.

Under CAS there are three general categories of analytical procedures, those used as a risk assessment procedure, substantive analytical procedures, and those that assist when forming an overall conclusion.

Risk Assessment Procedures

As the CAS are a fundamentally a risk based approach to auditing CAS 315 Identifying and Assessing the Risks of Material Misstatement is in many ways the cornerstone standard within the CAS. CAS 315. 14 requires the auditor to include analytical procedures as part of their risk assessment procedures.  The guidance for this type of analysis is included in CAS 315. A27- A31:

Substantive Analytical Procedures

The substantive procedures used by an auditor may include tests of details, substantive analytical procedures, or a combination of both. Ultimately, the determination of which procedures to perform, including whether to use substantive analytical procedures, is based on the expected effectiveness and efficiency of the available audit procedures to reduce audit risk at the assertion level to an acceptably low level.  In other words, there is no specific requirement under the CAS for the auditor to use substantive analytical procedures.  However, when applied appropriately they will often provide better audit evidence then do tests of detail and in many instances are also more efficient than tests of detail.

In general, there are four factors to consider when choosing to use an analytical procedure over another form of audit evidence.  Those factors are:

1. The existence of a plausible and predictable relationship between financial and non-financial data;
2. The nature of the assertion being addressed;
3. The reliability of the data used to develop the expectation; and
4. The precision of the expectation.

CAS 520.5 provides guidance for when the auditor decides to use substantive analytical procedures:

Analytical Procedures that Assist When Forming an Overall Conclusion

The third category of analytical procedures are used near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity.  These procedures are a required by CAS 520 paragraph 6 as part of the audit and are often similar to the procedures used at the risk assessment stage.  CAS 520.A17-19 provides guidance on these final analytics: