In: Accounting
ISA 520 Analytical Procedures explain the concept of analytical procedures and its uses throughout the audit.
Required:
(i) What is meant by the term ‘analytical procedures’ (1 mark)
(ii)What are the different types of analytical procedures available to the auditor
(iii) Identify and explain THREE (3) opportunities for using analytical procedure during the different stages of the audit, including how the auditor may use such information derived from the analysis. (3 marks)
(iv) Outline THREE (3) important factors to consider in using analytical procedure as a substantive test
ANS : (i) 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.
ANS : (ii) Three types of analytical procedures commonly used by auditors are trend analysis, ratio analysis and reasonableness testing
(1) Trend analysis This involves the analysis of changes in an account over time. This is more effective for a company whose business demonstrates a consistent sales pattern. Take the example of a company that sells furniture in Singapore. Based on the audit of the company in the last few years, the auditor has identified the company’s sales pattern: sales are generally higher in festive months. Hence, if sales during non-festive months are exceptionally high, it is an indication of potential risk of material misstatement and the auditor needs to investigate further and consider performing additional audit procedures.
(2) Ratio analysis This includes comparison with benchmarks, or comparing relationships between financial statements accounts and between an account and non-financial data. Let’s illustrate using an example where a company purchases products from its related companies and sells to its customers at a fixed gross profit (GP) margin of 22% on a backto-back basis. In addition to a test on details performed on the individual sales and purchases transaction, the auditor can also obtain assurance by analysing the GP margin of each sales transaction. If the GP margin deviates from 22%, the auditor would need to investigate and obtain appropriate corroborative audit evidence on the deviation identified.
(3) Reasonableness testing This involves the analysis of accounts, or changes in account between accounting periods, that entails the development of a model to form an expectation based on financial data, non-financial data, or both. For example, rental of office premises at a monthly rate of $10,000 is supported by a signed rental agreement between the company and the landlord. Multiplying the monthly rental against the rental period would give the auditor an estimated rental expenses to check against the rental expenses recorded in the general ledger. Similarly, any difference identified needs to be investigated, corroborated, and documented.
ANS : (iii)
Analytical procedures are performed at three stages of audit, namely planning, execution and completion, serving three primary purposes:
(1) Risk assessment The auditor carries out analytical procedures at the planning stage to identify financial statement areas that are of higher risk for the purpose of directing the focus of the audit.
(2) Obtain assurance The auditor may obtain assurance through substantive analytical procedures only or in combination with other audit testing (such as tests of controls and substantive test of details) in respect of the applicable assertions on financial statement areas.
(3) Final analytical review The auditor performs analytical procedures at the end of the audit to assess whether the financial statements are consistent with the auditor’s understanding of the entity. Where the results of the overall analytical review identify an inconsistent trend which may imply potential misstatement, the auditor needs to investigate the reason, re-assess the risk of the affected balance and perform further audit procedures. To achieve its purpose, a final analytical review should be performed on the final adjusted numbers at the end of the audit.
ANS : (iv)
(• The accuracy with which the expected results of substantive
analytical
procedures can be predicted. For example, the auditor will
ordinarily
expect greater consistency in comparing gross profit margins from
one
period to another than in comparing discretionary expenses, such
as
research or advertising.
• The degree to which information can be disaggregated. For
example,
substantive analytical procedures may be more effective when
applied to
financial information on individual sections of an operation or to
financial
statements of components of a diversified entity, than when applied
to the
financial statements of the entity as a whole.
• The availability of the information, both financial and
non-financial. For
example, the auditor considers whether financial information, such
as
budgets or forecasts, and non-financial information, such as the
number of
units produced or sold, is available to design substantive
analytical
procedures. If the information is available, the auditor also
considers the
reliability of the information as discussed in paragraphs 12c and
12d
above.