Analytical procedures are used in the financial audit

Analytical procedures are form of audit evidence. to assist in the understanding of business operations
and in the identification of potential risk areas that
need to be addressed.
It consist of evaluations of financial information
through analysis of plausible relationships among
both financial and non-financial data.

WHAT ARE ANALYTICAL

PROCEDURES?

Auditors perform these assessments to Analytical procedures are auditing

compare financial statements and procedures that involve analysis of
expected relationships between relationship between financial and
financial and non-financial data in an non-financial data.
effort to find inconsistencies.

These procedures can indicate possible problems with the

financial records of a client, which can then be investigated
more thoroughly.
Analytical procedures help an auditor understand
the client's business and changes in the business,
and to identify potential risk areas to plan other
audit procedures.
NATURE OF ANALYTICAL EXAMPLES OF ANALYTICAL
PROCEDURES PROCEDURES

According to Smith (2000), the analysis of analytical

EXAMPLE 1
procedures usually considers both comparisons and
Mr. Kingston is an auditor at company One-
relationship:
wannabee Sixy Co. and he is asked to determine
 Comparisons
potential risk areas. Mr. Kingston believes that the
Financial information is compared, for
implementation of analytical procedures is the most
example, with:
efficient tool in his effort to understand the business
a.) Prior periods (historical data)
operation and lower the risk of misstatements in
b.) Budgets and forecasts (future-oriented
the financial statements to the lowest acceptable
data)
level.
c.) Predictive estimates (e.g. of the annual
depreciation charge)
Here are the steps that Freddie takes in the process:
d.) Industry averages
1. He designs the analytical procedures taking
 Relationships into account the GAAP standards.
Typically, relationships are considered 2. He determines the appropriateness of
between: procedures for given claims, considering
a.) Elements of financial information which particular risks associated with the
are expected to adhere to a predicted business’s operations.
pattern (e.g. gross profit percentage) 3. He assesses the reliability of financial data to
b.) Financial and non-financial information calculate financial ratios and compare them
(e.g. hotel revenue to room occupancy)
to those of previous fiscal years to draw
conclusions.
4. He assesses the importance of information
PURPOSE OF ANALYTICAL available.
5. He assesses whether his projections are
PROCEDURES sufficiently precise.
6. He calculates any discrepancies of recorded
The purpose of analytical procedures is to assist in amounts from expected values.
planning the nature, timing and extend of other 7. He reaches a firm conclusion with respect to
audit procedures. Next, it will be also applied as the consistency of financial statements with
substantive procedures when their use is more his understanding of the business.
effective or efficient than tests of details. Lastly, it 8. If he identifies inconsistencies and/or
serves the purpose of an overall review to conclude fluctuations between the projected and the
whether financial statement as a whole is consistent actual values by a significant amount, he is
with auditors’ knowledge of the business, (McDaniel required to investigate the differences by
and Simmons, 2007). reaching out to the firm’s management.

An inconsistency that Mr. Kingston might find is cash

balances that do not match income and expense
reports. For example, the company might report
excessively high income and low expenses for the
year in an effort to increase investor interest in the
company, but the cash flows might tell a different
story.
EXAMPLE 2

Ms. Sean is auditing the financial statements of

5BSA Co. for the year ended 31 December 2016. In
the financial year 2015, 5BSA Co. had 100
employees and its total salaries expense amounted
to P 6 million. The company's business suffered in
financial year 2016, so no employee received any
raise. The company had to lay off 10 of its
employees from different divisions. The salaries
expense for financial year 2016 amounted to
P 5.5 million. Obtain audit evidence by application
of analytical procedures.

Total Salary Expense

Salary per employee =
in 2011 Number of Employees

P 6,000,000
= = P 60,000
100

Total salaries expense for financial year 2016 (for 90

employees) = 90 × 60,000 = P 5.4 million

In order to simply the analysis, we have assumed

that employees are laid off right at the start of
financial year 2016. In reality, a lot of fine-tuning is
done to analytical procedures to refine the results.
Any inconsistencies and differences are
investigated. In this example, one reason for the
difference of P 0.1 million between projected
salaries expense for financial year 2016 and actual
salaries expense for financial year 2016 can be a
mid-year layoff instead of the assumed start-of-the-
year layoff.