Question

Audit Analytical Procedures

1. Explain what is meant by Analytical Procedure as used in audit

2. Outline the 3 main types of Analytical Procedures

3. Identify and explain the 3 main uses of Analytical Procedures during the audit

4. Develop audit procedures for the use of analytical procedures as a substantive procedure in the testing of the reasonableness of monthly payroll costs for the year

Answer 1

Sol-1.

Analytical procedures are auditing procedures that involve analysis of relationship between financial and non-financial data. These involve investigation of identified variances and relationships that seem inconsistent with each other or with other available audit evidence.

Analytical procedures are carried out at the planning stage to assess the risk inherent in the financial statements as a whole and in each account head. They are carried at the execution stage to obtain audit evidence. They are also carried out at the time of finalization of an audit to make sure the overall conclusions drawn are consistent.

2.The 3 main types of Analytical Procedures:

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.
2. Ratio Analysis-This includes comparison with benchmarks, or comparing relationships between financial statements accounts and between an account and non-financial data.
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.

3.The 3 main uses of Analytical Procedures during the audit:

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 auditor’s understanding of the entity. Final analytical procedures are not conducted to obtain additional substantive assurance. If irregularities are found, risk assessment should be performed again to consider any additional audit procedures are necessary.

4.Substantive procedure in the testing of the reasonableness of monthly payroll costs can be done in following ways:

1. To ensure that employees are only paid for work done.
   Test of control – observe clocking on procedures and the level of supervision.
   Substantive procedure – select a sample of employees from the payroll and agree hours paid to individual clock cards.
   
2. To ensure that wages are only paid to valid employees.
   Test of control – attend the wages pay out.
   Substantive procedure – select a sample of employees from the payroll and vouch to individual contracts of employment in HR department.
   
3. To ensure that all wages are authorised.
   Test of control – review overtime forms/lists for authorised signatures.
   Substantive procedure – compare overtime costs each month with the prior year and investigate significant variances.
   
4. To ensure wages are paid at the correct rates of pay.
   Test of control – review log of amendments to master file for evidence of independent review.
   Substantive procedure – obtain printout of employee wage rates and compare to HR records.
   
5. To ensure that errors do not occur in payroll calculations.
   Test of control – review payrolls for signatures as evidence of independent calculation checks.
   Substantive procedure – select a sample of employees and check calculations of gross and net pay.