CPA Exam AUD: Analytical Procedures in Auditing
Understand analytical procedures for the CPA AUD exam. Learn when they are required, how to develop expectations, and how to investigate significant differences.
Analytical Procedures in Auditing: CPA Exam Guide
Analytical procedures are evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data. They are a powerful audit tool used at different stages of the audit for different purposes. AU-C Section 520 (Analytical Procedures) establishes the requirements for using analytical procedures during the audit.
When Analytical Procedures Are Required
Analytical procedures are required at two stages of the audit. During the planning stage, analytical procedures are required as risk assessment procedures to enhance the auditor's understanding of the entity and its environment and to identify areas of potential risk. During the overall review stage (near the end of the audit), analytical procedures are required to assess whether the financial statements as a whole are consistent with the auditor's understanding of the entity. The use of analytical procedures as substantive procedures during the audit is optional, though they can be highly effective when used appropriately.
Types of Analytical Procedures
Common types include trend analysis (comparing current-year balances or ratios to prior years), ratio analysis (calculating financial ratios such as gross margin, current ratio, debt-to-equity, and comparing them to expectations or industry data), reasonableness testing (developing an independent expectation of an amount using financial or nonfinancial data), and regression analysis (using statistical methods to develop expectations based on relationships among variables).
The precision of the expectation varies depending on the purpose. During planning, the auditor uses broad analytical procedures such as comparing overall financial statement balances to prior years and scanning for unusual items. During the overall review, the auditor reads the financial statements and considers whether they appear reasonable. When used as substantive procedures, the analytical procedures must develop a sufficiently precise expectation to detect material misstatement.
Developing Expectations
When analytical procedures are used as substantive procedures, the auditor must develop an expectation of the recorded amount that is sufficiently precise to identify a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated. The auditor considers the accuracy with which the expected results can be predicted, the degree to which information can be disaggregated (more disaggregated data generally improves precision), and the availability and reliability of underlying data.
The expectation should be developed using data that is independent of the amounts being tested. For example, when testing interest expense, the auditor might multiply average outstanding debt by the weighted average interest rate and compare the result to the recorded amount. Factors that increase the precision of analytical procedures include using data from multiple sources, using nonfinancial data to develop expectations, and disaggregating data into smaller components.
Investigating Significant Differences
When analytical procedures reveal significant unexpected differences between the expected and recorded amounts, the auditor must investigate. Investigation typically begins with inquiries of management, followed by corroboration of management's explanations with additional audit evidence. If management cannot provide a satisfactory explanation, or if the explanation cannot be corroborated, the auditor may need to perform additional substantive procedures to determine whether a misstatement exists. The auditor should not simply accept a plausible explanation without obtaining corroborating evidence.
Planning Stage Analytical Procedures
During planning, analytical procedures help the auditor identify potential problem areas and unusual transactions or events. The auditor may compare current-year unaudited balances to audited prior-year balances, compare current-year unaudited balances to budgets or forecasts, analyze trends over multiple periods, compare the entity's ratios to industry averages, and scan the data for unusual or unexpected items. These procedures help the auditor assess the risks of material misstatement and plan the nature, timing, and extent of further audit procedures.
Overall Review Stage Analytical Procedures
The purpose of analytical procedures in the overall review stage is to assist the auditor in assessing whether the financial statements are consistent with the auditor's understanding of the entity. This is essentially a final reasonableness check. If analytical procedures performed at this stage identify previously unrecognized risks of material misstatement, the auditor must revise the risk assessment and may need to perform additional audit procedures. This review is performed by a partner or manager with sufficient knowledge and experience.
Limitations of Analytical Procedures
Analytical procedures have limitations. They are less effective when relationships among data items are not predictable, when the data used to develop expectations is not reliable, or when the level of aggregation is too high. They are generally not suitable as the sole substantive procedure for significant risks. Analytical procedures may not detect misstatements that are offset by other misstatements (for example, overstatement of revenue offset by overstatement of expenses). For accounts with low predictability or high risk, tests of details are generally more appropriate than analytical procedures.
Exam Tips for Analytical Procedures
- Analytical procedures are required during planning and overall review stages; optional as substantive procedures.
- Substantive analytical procedures must develop a precise expectation and investigate significant differences.
- More disaggregated data and reliable data sources improve the precision of analytical procedures.
- Analytical procedures alone are insufficient for significant risks.
- The overall review is a reasonableness check performed by experienced personnel.
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