Audit is all about giving opinion that is backed up by relevant adequate audit evidence. Sufficient audit evidence doesn’t just appear out of thin air; analytical procedure is one of the many veritable audit evidence gathering techniques that an auditor uses.
Analytical procedure is a type of substantive procedure that auditors carry out during the process of audit evidence gathering exercise. The other type of test that auditors perform is the test of controls – designed to test the effectiveness of transactional level controls used by an entity.
Analytical procedures can either be performed manually or by CAATs especially when the organization is fully automated.
What is analytical procedure?
Analytical procedures are intentional and deliberate action that is performed by an auditor with the aim of obtaining audit evidence. Analytical procedures are sometimes called reasonableness test – this makes sense as what the auditor is doing when they conduct analytical procedures is basically comparing facts and figures as presented by management.
These facts and figures may come from varied sources. Analytical procedures according to the audit standard must be applied in the planning stage of audit engagement. Analytical procedures point me to areas where I will need to allocate more resources for the actual audit work.
A well performed analytical procedure can help identify potential fraud and misstatements. It is an ideal starting point of your audit risk assessment phase.
What are the Five (5) steps of analytical procedure?
Audit practitioners should carry out five steps when performing analytical procedures. They are:
- Be skeptically expectant: experienced auditors rely on various sources of information to make calculated expectations about a company’s financial outlook. A company with a business model that purely relies on an industry that is experiencing economic turmoil cannot be expected to have high margins. A classic example is the airline industry during the heat of COVID 19 pandemic.
- Agree on margins: this is where the professional agrees on what percentage of difference will be acceptable for the tasks. For example, will it be okay if my result falls outside 5% of the expectation that I have set above?
- Perform and Compare: Perform calculations and compare them with expectations set in step one. The use of horizontal and vertical ratio analysis technique is usually employed here.
- Investigate any significant variance: the whole aim of engaging in an analytical exercise is to establish reasonableness of found relationships. When these relationships don’t make sense, the auditor is then prompted to do more work all in the bid to obtain more clarification – assuming they exist.
- Thoroughly document all the steps taken. I tend to also populate my risk register at this point.
Seven (7) components or types of analytical procedure
To be able to effectively perform the above tasks, auditors must ensure that the below components of analytical procedures are judiciously adhered to.
- Analytical review: this is more like a high level analytical relational overview geared towards establishing common relationships with keen eyes on outliers. Things as simple as comparing budget vs actual figures may reveal things that you never imagined. Beniesh model when combined with Altman’s Z-Score reveals a lot. Also, the use of business technologies has made it possible for data driven auditors to leverage on the power of bigdata.
- Inquiry: this is where we put on our inquisitive hats on. We ask questions through all acceptable means making sure that we leave an audit trail as we do so.
- Observation: in lean six sigma methodology, this process of observing things first hand is called ‘gemba walk’. One thing about observation is that it always delivers as people cannot pretend for too long.
- Document examination: I have seen a situation where auditors fail to detect fraud that was perpetrated involving paying a particular invoice multiple times. Simple document examination would have highlighted the duplicate invoice.
- Re-performance: pick up that calculator to make sure that 2+3 is indeed 5. Re-performing bank reconciliations is a very useful analytical procedure that must not be taken lightly. I make use of excel formula in bank reconciliation thereby making my job faster and seamless.
- Confirmation: send that letter to people linked with both receivables and payables. Technology has made it very simple to do nowadays.
- Inspection: one thing is to be shown cartons of goods in the warehouse or vehicles parked, another thing is to ensure that they are actually what they purport to represent. Are those cartons of goods actually filled with quality inventories or are they simply empty cartons? What about the vehicles, are they actually moveable? Through inspections answers will be obtained. As an auditor, you already know that more work needs to be done if you find that more than half of the cartons parked in the warehouse are empty.
Advantages of analytical procedures
Some of the advantages of analytical procedures include; speedy completion of audit, points auditors in the direction of problem areas, helps to build evidence
Disadvantages of analytical procedures
Disadvantages of analytical procedures includes the fact that output maybe misinterpreted.
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