Analytical Procedures

Analytical procedures are a form of audit evidence.

Analytical procedures are an important type of evidence on an audit. They

involve a comparison of recorded values with expectations developed by
the auditor. They consists of evaluations of financial information made by a
study of plausible relationships among both financial and nonfinancial data.
For example, the current-year accounts receivable balance can be compared
to the prior-years' balances after adjusting for any increase or decrease in
sales and other economic factors.
There are three types of analytical procedures:
1. Preliminary analytical procedures
2. Substantive analytical procedures
3. Final analytical procedures
Auditing standards require that the auditor conduct analytical procedures in
planning the audit. Analytical procedures can be helpful in identifying the
existence of unusual transactions or events and amounts, ratios, and trends
that might have implications for audit planning.

Substantive Analytical Procedures

Analytical Procedures involve a comparison of recorded values with

expectations developed by the auditor.

Substantive analytical procedures are one of three types of analytical

procedures. They are used as a substantive procedure to obtain evidence
about particular assertions related to account balances or classes of
transactions.

Analytical procedures are one of many financial audit processes which

help an auditor understand the client's business and changes in the
business, and to identify potential risk areas to plan other audit
procedures.
Analytical procedures include comparison of financial information (data
in financial statement) with
 1. prior periods Analytical procedures are an important part of the audit process and consist
2. budgets of evaluations of financial information made by a study of plausible
3. forecasts relationships among both financial and nonfinancial data. Analytical
4. similar industries and so on. procedures range from simple comparisons to the use of complex models
It also includes consideration of predictable relationships, such as: involving many relationships and elements of data. A basic premise
underlying the application of analytical procedures is that plausible
1. gross profit to sales, relationships among data may reasonably be expected to exist and continue
2. payroll costs to employees, in the absence of known conditions to the contrary. Particular conditions
3. financial information and non-financial information, for examples that can cause variations in these relationships include, for example, specific
the CEO's reports and the industry news. unusual transactions or events, accounting changes, business changes,
random fluctuations, or misstatements.
possible sources of information about the client include:
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1. interim financial information Understanding financial relationships is essential in planning and evaluating
2. Budgets the results of analytical procedures, and generally requires knowledge of
3. Management accounts the client and the industry or industries in which the client operates. An
4. Non-Financial information understanding of the purposes of analytical procedures and the limitations
5. Bank and cash records of those procedures is also important. Accordingly, the identification of the
6. VAT returns relationships and types of data used, as well as conclusions reached when
7. Board minutes recorded amounts are compared to expectations, requires judgment by the
8. Discussion or correspondence with the client at the year-end auditor.
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Analytical procedures are used for the following purposes:
Analytical procedures are performed at three stages of audit: at start, in To assist the auditor in planning the nature, timing, and extent of
middle and at end of audit. These three stages are risk assessment other auditing procedures
procedures, substantive analytical procedures, and final analytical As a substantive test to obtain evidential matter about particular
procedures. assertions related to account balances or classes of transactions
Risk assessment procedures are used to assist the auditor to better As an overall review of the financial information in the final review
understand the business and to plan the nature, timing and extent of audit stage of the audit
procedures. Analytical procedures should be applied to some extent for the
purposes referred to in (a) and (c) above for all audits of financial
Substantive analytical procedures are used to obtain evidential matter
statements made in accordance with generally accepted auditing
about particular assertions related to account balances or classes of
standards. In addition, in some cases, analytical procedures can be
transactions.
more effective or efficient than tests of details for achieving
Final analytical procedures are used as an overall review of the financial particular substantive testing objectives.
information in the final review stage of the audit. .05
Analytical procedures involve comparisons of recorded amounts, or ratios
developed from recorded amounts, to expectations developed by the
auditor. The auditor develops such expectations by identifying and using
plausible relationships that are reasonably expected to exist based on the
auditor's understanding of the client and of the industry in which the client
operates. Following are examples of sources of information for developing
expectations:
Financial information for comparable prior period(s) giving
consideration to known changes
Anticipated resultsfor example, budgets, or forecasts including
extrapolations from interim or annual data
Relationships among elements of financial information within the
period
Information regarding the industry in which the client operatesfor
example, gross margin information
Relationships of financial information with relevant nonfinancial
information
Analytical Procedures in Planning the Audit
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The purpose of applying analytical procedures in planning the audit is to
assist in planning the nature, timing, and extent of auditing procedures that
will be used to obtain evidential matter for specific account balances or
classes of transactions. To accomplish this, the analytical procedures used in
planning the audit should focus on (a) enhancing the auditor's
understanding of the client's business and the transactions and events that
have occurred since the last audit date, and (b) identifying areas that may
represent specific risks relevant to the audit. Thus, the objective of the
procedures is to identify such things as the existence of unusual
transactions and events, and amounts, ratios and trends that might indicate
matters that have financial statement and audit planning ramifications.
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Analytical procedures used in planning the audit generally use data
aggregated at a high level. Furthermore, the sophistication, extent and
timing of the procedures, which are based on the auditor's judgment, may
vary widely depending on the size and complexity of the client. For some
entities, the procedures may consist of reviewing changes in account
balances from the prior to the current year using the general ledger or the
auditor's preliminary or unadjusted working trial balance. In contrast, for
other entities, the procedures might involve an extensive analysis of
quarterly financial statements. In both cases, the analytical procedures,
combined with the auditor's knowledge of the business, serve as a basis for
additional inquiries and effective planning.
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Although analytical procedures used in planning the audit often use only
financial data, sometimes relevant nonfinancial information is considered as
well. For example, number of employees, square footage of selling space,
volume of goods produced, and similar information may contribute to
accomplishing the purpose of the procedures.
Analytical Procedures Used as Substantive Tests
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The auditor's reliance on substantive tests to achieve an audit objective
related to a particular assertion fn 1 may be derived from tests of details,
from analytical procedures, or from a combination of both. The decision
about which procedure or procedures to use to achieve a particular audit
objective is based on the auditor's judgment on the expected effectiveness
and efficiency of the available procedures.
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The auditor considers the level of assurance, if any, he wants from
substantive testing for a particular audit objective and decides, among other
things, which procedure, or combination of procedures, can provide that
level of assurance. For some assertions, analytical procedures are effective
in providing the appropriate level of assurance. For other assertions,
however, analytical procedures may not be as effective or efficient as tests
of details in providing the desired level of assurance.
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The expected effectiveness and efficiency of an analytical procedure in
identifying potential misstatements depends on, among other things, (a) the
nature of the assertion, (b) the plausibility and predictability of the
relationship, (c) the availability and reliability of the data used to develop
the expectation, and (d) the precision of the expectation.
Nature of Assertion
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Analytical procedures may be effective and efficient tests for assertions in
which potential misstatements would not be apparent from an examination
of the detailed evidence or in which detailed evidence is not readily
available. For example, comparisons of aggregate salaries paid with the
number of personnel may indicate unauthorized payments that may not be
apparent from testing individual transactions. Differences from expected
relationships may also indicate potential omissions when independent
evidence that an individual transaction should have been recorded may not
be readily available.
Plausibility and Predictability of the Relationship
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It is important for the auditor to understand the reasons that make
relationships plausible because data sometimes appear to be related when
they are not, which could lead the auditor to erroneous conclusions. In
addition, the presence of an unexpected relationship can provide important
evidence when appropriately scrutinized.
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As higher levels of assurance are desired from analytical procedures, more
predictable relationships are required to develop the expectation.
Relationships in a stable environment are usually more predictable than
relationships in a dynamic or unstable environment. Relationships involving
income statement accounts tend to be more predictable than relationships
involving only balance sheet accounts since income statement accounts
represent transactions over a period of time, whereas balance sheet
accounts represent amounts as of a point in time. Relationships involving
transactions subject to management discretion are sometimes less
predictable. For example, management may elect to incur maintenance
expense rather than replace plant and equipment, or they may delay
advertising expenditures.
Analytical Procedures Used in the Overall Review
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The objective of analytical procedures used in the overall review stage of
the audit is to assist the auditor in assessing the conclusions reached and in
the evaluation of the overall financial statement presentation. A wide
variety of analytical procedures may be useful for this purpose. The overall
review would generally include reading the financial statements and notes
and considering (a) the adequacy of evidence gathered in response to
unusual or unexpected balances identified in planning the audit or in the
course of the audit and (b) unusual or unexpected balances or relationships
that were not previously identified. Results of an overall review may
indicate that additional evidence may be needed.
To obtain audit evidence, the auditor performs one or a combination of
the following procedures:
1. inspection
2. observation
3. external confirmation
4. inquiry
5. reperformance
6. recalculation
7. analytical procedures.
It is mandatory that the auditor should perform risk assessment for the
identification and assessment of risks of material misstatement at the
financial statement and assertion level, and the risk assessment procedures
should include analytical procedures (ISA 315). It is also mandatory that the
auditor should perform analytical procedures near the end of the audit that
assess whether the financial statements are consistent with the auditors
understanding of the entity (ISA 520).
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.
DEFINITION OF ANALYTICAL PROCEDURES
Analytical procedures consist of evaluations of financial information
through analysis of plausible relationships among both financial and non-
financial data. They 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 (ISA 520). A basic premise underlying the application of analytical
procedures is that plausible relationships among data may reasonably be
expected to exist and continue in the absence of conditions to the contrary.
PURPOSES OF ANALYTICAL PROCEDURES
Analytical procedures are used throughout the audit process and are
conducted for three primary purposes:
1. PRELIMINARY ANALYTICAL REVIEW risk assessment (required by
ISA 315)
 Preliminary analytical reviews are performed to obtain an
understanding of the business and its environment (eg financial
performance relative to prior years and relevant industry and
comparison groups), to help assess the risk of material
misstatement in order to determine the nature, timing and extent
of audit procedures, ie to help the auditor develop the audit
strategy and programme.
2. SUBSTANTIVE ANALYTICAL PROCEDURES
Analytical procedures are used as substantive procedures when the
auditor considers that the use of analytical procedures can be more
effective or efficient than tests of details in reducing the risk of
material misstatements at the assertion level to an acceptably low
level.
3. FINAL ANALYTICAL REVIEW (REQUIRED BY ISA 520)
Analytical procedures are performed as an overall review of the
financial statements at the end of the audit to assess whether they
are consistent with the auditors understanding of the entity. Final
analytical procedures are not conducted to obtain additional
substantive assurance. If irregularities are found, risk assessment
should be perfor
Assertions in the Audit of Financial Statements
Definition
Audit Assertions are the implicit or explicit claims and representations
made by the management responsible for the preparation of financial
statements regarding the appropriateness of the various elements of financial
statements and disclosures.
Audit Assertions are also known as Management Assertions and Financial
Statement Assertions.
Explanation
In preparing financial statements, management is making implicit or explicit
claims (i.e. assertions) regarding the recognition, measurement and
presentation of assets, liabilities, equity, income, expenses and disclosures in
accordance with the applicable financial reporting framework (e.g. IFRS).
For example, if a balance sheet of an entity shows buildings with carrying
amount of $10 million, the auditor shall assume that the management has
claimed that:
The buildings recognized in the balance sheet exist at the period end;
The entity owns or controls those buildings;
The buildings are valued accurately in accordance with the measurement
basis;
All buildings owned and controlled by the entity are included within the
carrying amount of $10 million.

Types & Examples

Assertions may be classified into the following types:
Assertions relating to classes of transactions

Assertions Explanation Examples: Salaries & Wages Cost

Occurrence Transactions Salaries & wages expense has

recognized in the been incurred during the period in
financial statements respect of the personnel
have occurred and employed by the entity. Salaries
relate to the entity. and wages expense does not
include the payroll cost of any
unauthorized personnel.
Completeness All transactions that Salaries and wages cost in respect
were supposed to be of all personnel have been fully
recorded have been accounted for.
recognized in the
financial statements.
Accuracy Transactions have Salaries and wages cost has been
been recorded calculated accurately. Any
accurately at their adjustments such as tax deduction
appropriate amounts. at source have been correctly
reconciled and accounted for.
Cut-off Transactions have Salaries and wages cost
been recognized in recognized during the period
the correct relates to the current accounting
accounting periods. period. Any accrued and prepaid
expenses have been accounted for
correctly in the financial
statements.
Classification Transactions have Salaries and wages cost has been
been classified and fairly allocated between:
presented fairly in -Operating expenses incurred in
the financial production activities;
statements. -General and administrative
expenses; and
-Cost of personnel relating to any
self-constructed assets other than
inventory.
Existence Assets, liabilities and Inventory recognized in the balance
equity balances exist at sheet exists at the period end.
the period end.
Completeness All assets, liabilities All inventory units that should have
and equity balances been recorded have been recognized in
that were supposed to the financial statements. Any inventory
be recorded have been held by a third party on behalf of the
recognized in the audit entity has been included in the
financial statements. inventory balance.
Rights & Entity has the right to Audit entity owns or controls the
Obligations ownership or use of inventory recognized in the financial
the recognized assets, statements. Any inventory held by the
and the liabilities audit entity on account of another
recognized in the entity has not been recognized as part
financial statements of inventory of the audit entity.
represent the
obligations of the
entity.
Valuation Assets, liabilities and Inventory has been recognized at the
equity balances have lower of cost and net realizable value in
been valued accordance with IAS 2 Inventories. Any
appropriately. costs that could not be reasonably
allocated to the cost of production (e.g.
general and administrative costs) and
any abnormal wastage has been
excluded from the cost of inventory. An
acceptable valuation basis has been
used to value inventory cost at the
period end (e.g. FIFO, AVCO, etc.)

Assertions relating to assets, liabilities and equity balances at the period Assertions relating to presentation and disclosures
end
Assertions Explanation Examples: Related Party
Assertions Explanation Examples: Inventory balance Disclosures

Occurrence Transactions and events
disclosed in the financial
statements have occurred
and relate to the entity.
Completeness All transactions, balances,
events and other matters
that should have been
disclosed have been
disclosed in the financial
statements.
Classification & Disclosed events,
Understandability transactions, balances and
other financial matters
have been classified
appropriately and
presented clearly in a
manner that promotes the
understandability of
information contained in
the financial statements.
Accuracy & Transactions, events,
Valuation balances and other
financial matters have been
disclosed accurately at
their appropriate amounts.
Purpose & Importance
Assertions assist auditors in considering a wide range of issues that are
relevant to the authenticity of financial statements. The consideration of
management assertions during the various stages of audit helps to reduce
the audit risk.
Transactions with related
parties disclosed in the notes of
financial statements have
occurred during the period and
relate to the audit entity.
All related parties, related
party transactions and balances
that should have been
disclosed have been disclosed
in the notes of financial
statements.
The nature of related party
transactions, balances and
events has been clearly
disclosed in the notes of
financial statements. Users of
the financial statements can
clearly determine the financial
statement captions affected by
the related party transactions
and balances and can easily
ascertain their financial effect.
Related party transactions,
balances and events have been
disclosed accurately at their
appropriate amounts.
TRANSACTION ASSERTIONS
1. Occurrence this means that the transactions recorded or disclosed
actually happened and relate to the entity. For example that a
recorded sale represents goods which were ordered by valid customers
and were despatched and invoiced in the period. An alternative way of
putting this is that sales are genuine and are not overstated.
Relevant test select a sample of entries from the sales account in the nominal
ledger and trace to the appropriate sales invoice and supporting goods
despatched notes and customer orders.
2. Completeness this means that transactions that should have been
recorded and disclosed have not been omitted.
Relevant test select a sample of customer orders and check to despatch notes
and sales invoices and the posting to the sales account in the nominal ledger.
Note the difference in the direction of the above test. In order to test
completeness the procedure should start from the underlying documents and
check to the entries in the relevant ledger to ensure none have been missed. To
test for occurrence the procedures will go the other way and start with the
entry in the ledger and check back to the supporting documentation to ensure
the transaction actually happened.
3. Accuracy this means that there have been no errors while preparing
documents or in posting transactions to ledgers. The new reference to
disclosures being appropriately measured and described means that
the figures and explanations are not misstated.
Relevant test calculation checks on invoices, payroll, etc, and the review of
control account reconciliations are designed to provide assurance about
accuracy.
4. Cutoff that transactions are recorded in the correct accounting
period.
Relevant test recording last goods received notes and despatch notes at the
inventory count and tracing to purchase and sales invoices to ensure that goods
received before the yearend are recorded in purchases at the year end and
that goods despatched are recorded in sales.
 5. Classification transactions recorded in the appropriate accounts for
example,the purchase of raw materials has not been posted to repairs
and maintenance.
Relevant test check purchase invoices postings to nominal ledger accounts.
6. Presentation this means that the descriptions and disclosures of
transactions are relevant and easy to understand. There is a new
reference to transactions being appropriately aggregated or
disaggregated. Aggregation is the adding together of individual items.
Disaggregation is the separation of an item, or an aggregated group of
items, into component parts. The notes to the accounts are often used
to disaggregate totals shown in the profit or loss account. Materiality
needs to be considered when judgements are made about the level of
aggregation and disaggregation.
Relevant test check the total employee benefits expense is analysed in the
notes to the financial statements under separate headings ie wages and
salaries, pension costs, social security contributions and taxes, etc.
ACCOUNT BALANCE ASSERTIONS
1. Existence means that assets and liabilities really do exist and there
has been no overstatement for example,by the inclusion of fictitious
receivables or inventory. This assertion is very closely related to
the occurrence assertion for transactions.
Relevant tests physical verification of noncurrent assets, circularisation of
receivables, payables and the bank letter.
2. Rights and obligations means that the entity has a legal title or
controls the rights to an asset or has an obligation to repay a liability.
Relevant tests in the case of property, deeds of title can be checked. Current
assets are often checked to purchase invoices although these are primarily used
to confirm cost. Long term liabilities such as loans can be checked to the
relevant loan agreement.
3. Completeness that there are no omissions and assets and liabilities
that should be recorded and disclosed have been. In other words there
has been no understatement of assets or liabilities.
Relevant tests A review of the repairs and expenditure account can
sometimes identify items that should have been capitalised and have been
omitted from noncurrent assets. Reconciliation of payables ledger balances to
suppliers statements is primarily designed to confirm completeness although it
also gives assurance about existence.
4. Accuracy, valuation and allocation means that amounts at which
assets, liabilities and equity interests are valued, recorded and
disclosed are all appropriate. The reference to allocation refers to
matters such as the inclusion of appropriate overhead amounts into
inventory valuation.
Relevant tests Vouching the cost of assets to purchase invoices and checking
depreciation rates and calculations.
5. Classification means that assets, liabilities and equity interests are
recorded in the proper accounts.
Relevant tests the test for transactions of checking purchase invoice postings
to the appropriate accounts in the nominal ledger will be relevant again. Also
that research expenditure is only classified as development expenditure if it
meets the criteria specified in IAS 38.
6. Presentation this means that the descriptions and disclosures of
assets and liabilities are relevant and easy to understand. The points
made above aggregation and disaggregation of transactions also apply
to assets, liabilities and equity interests.
Relevant tests auditors often use disclosure checklists to ensure that financial
statement presentation complies with accounting standards and relevant
legislation. These cover all items (transactions, assets, liabilities and equity
interests) and would include for example checking that disclosures relating to
noncurrent assets include cost, additions, disposals, depreciation, etc.