Question

Why is it important for auditors to use analytical comparisons such as the ratios in the Sunbeam case to evaluate possible red flags that may indicate additional auditing is required? How does making such calculations enable auditors to meet their ethical obligations

Answer 1

Analytical procedures involve evaluations of financial statement information by a study of relationships between financial and nonfinancial date. A basic premise using these procedures is that relationships among the data may exist. Auditors can use these relationships to obtain evidence about the reasonableness of the financial statement amounts.

Techniques used in performing analytical procedures range in sophistication from analysis of trends and ratios to complex regression modeling of many relationships and data from previous years. This may range from comparing revenue and expense amounts for the current year to prior years, to a regression model to estimate the amount of sales for the year using economic and industry data. The auditors attempt to identify unexpected differences or the absence of expected differences.

Auditing standards require the application of analytical procedures at the planning and overall final review stages of the audit. The auditors may also use analytical procedures during the audit to test the reasonableness of accounts; in which case, the procedures provide substantive evidence. Analytical procedures performed during the planning stage of the audit assess risk and help to determine the nature, timing, and extent of audit procedures. The auditors used the analytical procedures to identify unusual transactions or amounts that should be tested during the audit. Analytical procedures used in the overall review stage of the audit assist the auditor in assessing the adequacy and sufficiency of the evidence collected and the validity of the conclusions drawn. If the unusual ratios remain after all adjusting entries, it should raise red flags that indicate more audit procedures are needed or that manipulations are being made by management.