Topic# 6 – Analytical Procedures

1. Topic# 6 – Analytical Procedures • Readings, pages 89-90,202 & 275-276. Authority : ISA 520 - Analytical Procedures, Para.2 "The auditor should apply analytical procedures at the planning and overall review stages of the audit. Analytical procedures may also be applied at other stages."

2. Definition – AP involves the analysis of relationships between: a) items of financial data, or between items of financial and non-financial data, deriving from the same period; or b) comparable financial information deriving from different time periods to identify consistencies and predicted patterns or significant fluctuations and unexpected relationships, and the results of investigation thereof.

3. Types of AP • Simple Trend Analysis (of one account) • Ratio analysis • Trend Analysis • Comparative Analysis • Common-sized analysis • Reasonableness tests

4. How to apply AP • Develop expectation • Determine acceptable difference from expectation • Compare account balance with expectation • Investigate significant differences

5. When to apply AP Analytical procedures can be applied to all the stages of the audit i.e. planning,fieldwork and final review.

6. Planning stage At the planning stage, they serve to identify areas of potential audit risk and help in planning the nature, timing and extent of other procedures.

7. Application of AP in Planning • Acquire the last audited financial statements • Acquire any projected financial statements or budgets established by management or perform some projections incorporating trend analysis (i.e. using the previous audited financial statements) • Compare the projections from 1. above with the client’s current un-audited financial statements to identify ratios/relationships that are out of sink.

8. Planning e.g. • See page 90 in text book • This example incorporates both ratio analysis and a simple trend analysis of certain account balances

9. Fieldwork Stage AP is used at this stage to obtain evidence about the financial statement account balances.

10. Fieldwork Stage e.g. #1 • One may wish to verify the reasonableness of recorded credit sales. • A reasonableness test could be applied where the auditor uses a debtors control account. He could add the all the cash received from debtors to the closing debtors figure and then subtract the opening debtors figure. He would then compare this result to the recorded credit sales figure.

11. Fieldwork Stage e.g. #2 • One may wish to verify the reasonableness of recorded payroll expenses. • A reasonableness test could be applied where the auditor determines the average pay per employee in each category. He would next determine the number of employees for the said categories. He would finally multiply these two figures for each category, sum all the categories and then compare this result to the recorded payroll expenses figure

12. Fieldwork Stage e.g. #3 • One may wish to verify the reasonableness of recorded production costs in a manufacturing entity. • E.g. the auditor wants to determine whether job No. 123 which has 950 direct labour hours really resulted in the recorded production costs of $42,000. • A regression analysis could be applied. (Recall that : y = a + bx ).

13. Fieldwork Stage e.g. #3 (cont’d) • Suppose that based on previous data, the following equation had been developed for matching production costs against labour hours: y = 30602 + 15.8436 x where y = production costs and x = labour hours • Job No. 123 should carry production costs of 30602 + 15.8436 (950) = $45,653.27

14. Fieldwork Stage e.g. #3 (cont’d) • This figure of $45,653.27 exceeds the $42,000 recorded in the general ledger. • As a result of this difference, additional inquiries and audit procedures may be necessary to determine if the difference is reasonable or if perhaps an error or fraud has occurred.

15. Final Review Stage AP is used at this stage to help the auditor assess the adequacy of substantive tests performed, the sufficiency of the evidential matter obtained and the validity of the conclusions reached, including the opinion on the financial statements taken as a whole.

16. The End!