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					01            tecHnicAl

relevAnt to AccA QuAlificAtion PAPers f8 AnD P7
AnD cAt PAPer 8

‘The	auditor	shall	design	and	perform	audit	procedures	that	are	appropriate	in	the	circumstances	for	the	
purpose	of 	obtaining	sufficient	appropriate	audit	evidence.’ (ISA/HKSA 500(6))

To obtain audit evidence, the auditor             1 Preliminary analytical review – risk               The	application	of 	substantive	analytical	
performs one – or a combination – of the            assessment (required by isA/HKsA 315(6b))       procedures	is	based	on	the	expectation	
following procedures:                               Preliminary	analytical	reviews	are	             that	relationships	among	data	exist	
¤	 inspection                                       performed	to	obtain	an	understanding	           and	continue	in	the	absence	of 	known	
¤	 observation                                      of 	the	business	and	its	environment	           conditions	to	the	contrary.	The	presence	of 	
¤	 external	confirmation                            (eg	financial	performance	relative	to	          these	relationships	provides	audit	evidence	
¤	 inquiry                                          prior	years	and	relevant	industry	and	          as	to	the	completeness,	accuracy	and	
¤	 reperformance                                    comparison	groups),	to	help	assess	the	         occurrence	of 	transactions.	Due	to	their	
¤	 recalculation                                    risk	of 	material	misstatement	in	order	        nature,	substantive	analytical	procedures	
¤	 analytical	procedures.                           to	determine	the	nature,	timing	and	            can	often	provide	evidence	for	multiple	
                                                    extent	of 	audit	procedures,	ie	to	help	the	    assertions,	identify	audit	issues	that	may	
It	is	mandatory	that	the	auditor	should	            auditor	develop	the	audit	strategy	and	         not	be	apparent	from	more	detailed	work,	
perform	risk	assessment	for	the	                    programme.                                      and	direct	the	auditor’s	attention	to	areas	
identification	and	assessment	of 	risks	of 	                                                        requiring	further	investigation.	Furthermore,	
material	misstatement	at	the	financial	           2 substantive analytical procedures               the	auditor	may	identify	risks	or	deficiencies	
statement	and	assertion	level,	and	the	risk	        Analytical	procedures	are	used	as	              in	internal	control	that	had	not	previously	
assessment	procedures	should	include	               substantive	procedures	when	the	auditor	        been	identified,	which	may	cause	the	
analytical	procedures	(ISA/HKSA	315(6b)).	          considers	that	the	use	of 	analytical	          auditor	to	re-evaluate	his	planned	audit	
It	is	also	mandatory	that	the	auditor	should	       procedures	can	be	more	effective	or	            approach	and	require	the	auditor	to	obtain	
perform	analytical	procedures	near	the	             efficient	than	tests	of 	details	in	reducing	   more	assurance	from	other	substantive	
end	of 	the	audit	that	assess	whether	the	          the	risk	of 	material	misstatements	at	the	     testing	than	originally	planned.
financial	statements	are	consistent	with	the	       assertion	level	to	an	acceptably	low	level.	       To	derive	the	most	benefit	from	
auditor’s	understanding	of 	the	entity	(ISA/                                                        substantive	analytical	procedures,	the	
HKSA	520(6)).                                     3 final analytical review (required by isA/HKsA   auditor	should	perform	substantive	
                                                    520(6))                                         analytical	procedures	before	other	
Analytical	procedures	are	also	commonly	            Analytical	procedures	are	performed	            substantive	tests	because	results	of 	
used	in	non-audit	and	assurance	                    as	an	overall	review	of 	the	financial	         substantive	analytical	procedures	often	
engagements,	such	as	reviews	of 	                   statements	at	the	end	of 	the	audit	to	         impact	the	nature	and	extent	of 	detailed	
prospective	financial	information,	and	             assess	whether	they	are	consistent	             testing.	Substantive	analytical	procedures	
non-audit	reviews	of 	historical	financial	         with	the	auditor’s	understanding	of 	           might	direct	attention	to	areas	of 	increased	
information.	While	the	use	of 	analytical	          the	entity.	Final	analytical	procedures	        risk,	and	the	assurance	obtained	from	
procedures	in	such	engagements	is	not	              are	not	conducted	to	obtain	additional	         effective	substantive	analytical	procedures	
covered	in	the	ISAs,	the	principals	regarding	      substantive	assurance.	If 	irregularities	      will	reduce	the	amount	of 	assurance	needed	
their	use	are	relevant.                             are	found,	risk	assessment	should	              from	other	tests.
                                                    be	performed	again	to	consider	                    There	are	four	elements	that	comprise	
Definition of AnAlyticAl ProceDures                 any	additional	audit	procedures	                distinct	steps	that	are	inherent	in	
Analytical	procedures	consist	of 	                  are	necessary.                                  the	process	to	using	substantial	
‘evaluations	of 	financial	information	through	                                                     analytical	procedures:	
analysis	of 	plausible	relationships	among	       use of substAntive
both	financial	and	non-financial	data’.	          AnAlyticAl ProceDures                             steP 1:
They	also	encompass	‘such	investigation	          One	of 	the	objectives	of 	ISA	520	is	that	       Develop an independent expectation
as	is	necessary	of 	identified	fluctuations	      relevant	and	reliable	audit	evidence	is	          The	development	of 	an	appropriately	
or	relationships	that	are	inconsistent	with	      obtained	when	using	substantive	analytical	       precise,	objective	expectation	is	the	
other	relevant	information	or	that	differ	        procedures.	The	primary	purpose	of 	              most	important	step	in	effectively	using	
from	expected	values	by	a	significant	            substantive	analytical	procedures	is	to	          substantive	analytical	procedures.	An	
amount’	(ISA/HKSA	520(4)).	A	basic	               obtain	assurance,	in	combination	with	other	      expectation	is	a	prediction	of 	a	recorded	
premise	underlying	the	application	of 	           audit	testing	(such	as	tests	of 	controls	and	    amount	or	ratio.	The	prediction	can	be	a	
analytical	procedures	is	that	plausible	          substantive	tests	of 	details),	with	respect	     specific	number,	a	percentage,	a	direction	
relationships	among	data	may	reasonably	          to	financial	statement	assertions	for	one	        or	an	approximation,	depending	on	the	
be	expected	to	exist	and	continue	in	the	         or	more	audit	areas.	Substantive	analytical	      desired	precision.	
absence	of 	conditions	to	the	contrary.	          procedures	are	generally	more	applicable	to	
                                                  large	volumes	of 	transactions	that	tend	to	
PurPoses of AnAlyticAl ProceDures                 be	more	predictable	over	time.	
Analytical	procedures	are	used	throughout	
the	audit	process	and	are	conducted	for	
three	primary	purposes:
                                                                  stuDent AccountAnt issue 18/2010
                                                                                            Studying Paper F8 or P7?
                                                             Performance objectives 17 and 18 are relevant to this exam


AnAlyticAl ProceDures consist of ‘evAluAtions of finAnciAl informAtion
tHrougH AnAlysis of PlAusible relAtionsHiPs Among botH finAnciAl
AnD non-finAnciAl DAtA’.

   The	auditor	should	have	an	independent	            It	is	important	to	note	that	the	              Key fActors Affecting tHe Precision
expectation	whenever	s/he	uses	substantive	        computation	of 	differences	should	               of AnAlyticAl ProceDures
analytical	procedures	(ISA/HKSA	520(5c)).	         be	done	after	the	consideration	of 	an	           There	are	four	key	factors	that	affect	the	
The	auditor	develops	expectations	by	              expectation	and	threshold.	In	applying	           precision	of 	analytical	procedures:	
identifying	plausible	relationships	(eg	           substantive	analytical	procedures,	it	is	not	
between	store	square	footage	and	retail	           appropriate	to	first	compute	differences	         1 Disaggregation
sales,	market	trends	and	client	revenues)	         from	prior-period	balances	and	then	let	the	      The	more	detailed	the	level	at	which	
that	are	reasonably	expected	to	exist	based	       results	influence	the	‘expected’	difference	      analytical	procedures	are	performed,	
on	his	knowledge	of 	the	business,	industry,	      and	the	acceptable	threshold.                     the	greater	the	potential	precision	of 	the	
trends,	or	other	accounts.	                                                                          procedures.	Analytical	procedures	
                                                   steP 4:                                           performed	at	a	high	level	may	mask	
steP 2:                                            investigate significant differences and           significant,	but	offsetting,	differences	that	
Define a significant difference (or threshold)     draw conclusions                                  are	more	likely	to	come	to	the	auditor’s	
While	designing	and	performing	substantive	        The	fourth	step	is	the	investigation	of 	         attention	when	procedures	are	performed	
analytical	procedures	the	auditor	should	          significant	differences	and	formation	of 	        on	disaggregated	data.	
consider	the	amount	of 	difference	from	the	       conclusions	(ISA/HKSA	520(7)).	Differences	          The	objective	of 	the	audit	procedure	will	
expectation	that	can	be	accepted	without	          indicate	an	increased	likelihood	of 	             determine	whether	data	for	an	analytical	
further	investigation	(ISA/HKSA	520(5d)).	         misstatements;	the	greater	the	degree	of 	        procedure	should	be	disaggregated	and	to	
The	maximum	acceptable	difference	is	              precision,	the	greater	the	likelihood	that	the	   what	degree	it	should	be	disaggregated.	
commonly	called	the	‘threshold’.	                  difference	is	a	misstatement.	                    Disaggregated	analytical	procedures	
   Thresholds	may	be	defined	either	as	               Explanations	should	be	sought	for	             can	be	best	thought	of 	as	looking	at	the	
numerical	values	or	as	percentages	of 	            the	full	amount	of 	the	difference,	not	          composition	of 	a	balance(s)	based	on	time	
the	items	being	tested.	Establishing	an	           just	the	part	that	exceeds	the	threshold.	        (eg	by	month	or	by	week)	and	the	source(s)	
appropriate	threshold	is	particularly	critical	    There	is	a	chance	that	the	unexplained	           (eg	by	geographic	region	or	by	product)	of 	
to	the	effective	use	of 	substantive	analytical	   difference	may	indicate	an	increased	             the	underlying	data	elements.	The	reliability	
procedures.	To	prevent	bias	in	judgment,	          risk	of 	material	misstatement.	The	              of 	the	data	is	also	influenced	by	the	
the	auditor	should	determine	the	threshold	        auditor	should	consider	whether	the	              comparability	of 	the	information	available	
while	planning	the	substantive	analytical	         differences	were	caused	by	factors	               and	the	relevance	of 	the	information	
procedures,	ie	before	Step	3,	in	which	the	        previously	overlooked	when	developing	the	        available.
difference	between	the	expectation	and	the	        expectation	in	Step	1,	such	as	unexpected	
recorded	amount	are	computed.	                     changes	in	the	business	or	changes	in	            2 Data reliability
   The	threshold	is	the	acceptable	amount	         accounting	treatments.	                           The	more	reliable	the	data	is,	the	more	
of 	potential	misstatement	and	therefore	             If 	the	difference	is	caused	by	factors	       precise	the	expectation.	The	data	used	to	
should	not	exceed	planning	materiality	            previously	overlooked,	it	is	important	to	        form	an	expectation	in	an	analytical	
and	must	be	sufficiently	small	to	enable	          verify	the	new	data,	to	show	what	impact	         procedure	may	consist	of 	external	industry	
the	auditor	to	identify	misstatements	that	        this	would	have	on	the	original	expectations	     and	economic	data	gathered	through	
could	be	material	either	individually	or	          as	if 	this	data	had	been	considered	in	          independent	research.	The	source	of 	
when	aggregated	with	misstatements	in	             the	first	place,	and	to	understand	any	           the	information	available	is	particularly	
other	disaggregated	portions	of 	the	account	      accounting	or	auditing	ramifications	of 	the	     important.	Internal	data	produced	from	
balance	or	in	other	account	balances.              new	data.                                         systems	and	records	that	are	covered	
                                                                                                     by	the	audit,	or	that	are	not	subject	to	
steP 3:                                                                                              manipulation	by	persons	in	a	position	to	
compute difference                                                                                   influence	accounting	activities,	are	generally	
The	third	step	is	the	comparison	of 	the	                                                            considered	more	reliable.	
expected	value	with	the	recorded	amounts	
and	the	identification	of 	significant	
differences,	if 	any.	This	should	be	simply	a	
mechanical	calculation.	
03            tecHnicAl

3 Predictability                                 tHe more Precision inHerent in An AnAlyticAl
There	is	a	direct	correlation	between	the	
predictability	of 	the	data	and	the	quality	     ProceDure useD, tHe greAter tHe PotentiAl
of 	the	expectation	derived	from	the	data.	      reliAbility of tHAt ProceDure.
Generally,	the	more	precise	an	expectation	
is	for	an	analytical	procedure,	the	greater	
will	be	the	potential	reliability	of 	that	        If 	the	auditor	needs	a	high	level	of 	
procedure.	The	use	of 	non-financial	data	       assurance	from	a	substantive	analytical	
(eg	number	of 	employees,	occupancy	             procedure,	s/he	should	develop	a	
rates,	units	produced)	in	developing	an	         relatively	precise	expectation	by	selecting	
expectation	may	increase	the	auditor’s	          an	appropriate	analytical	procedure	
ability	to	predict	account	relationships.	       (eg	a	reasonableness	test	instead	of 	a	
However,	the	information	is	subject	to	data	     simple	trend	or	‘flux’	analysis).	Thus,	
reliability	considerations	mentioned	above.      determining	which	type	of 	substantive	
                                                 analytical	procedure	to	use	is	a	matter	of 	
4 type of analytical procedures                  professional	judgment.
There	are	several	types	of 	analytical	            In	summary,	there	is	a	direct	correlation	
procedures	commonly	used	as	substantive	         between	the	type	of 	analytical	procedure	
procedures	and	will	influence	the	precision	     selected	and	the	precision	it	can	provide.	
of 	the	expectation.	The	auditor	chooses	        Generally,	the	more	precision	inherent	in	an	
among	these	procedures	based	on	his	             analytical	procedure	used,	the	greater	the	
objectives	for	the	procedures	(ie	purpose	of 	   potential	reliability	of 	that	procedure.
the	test,	desired	level	of 	assurance).
i	 	 rend	analysis	–	the	analysis	of 	changes	
    T                                            Key messages:
    in	an	account	over	time.                     ¤	 Substantive	analytical	procedures	
ii	 	 atio	analysis	–	the	comparison,	across	       play	an	important	part	in	a	risk-based	
    time	or	to	a	benchmark,	of 	relationships	      audit	approach.	
    between	financial	statement	accounts	        ¤	 Properly	designed	and	executed	analytical	
    and	between	an	account	and	non-                 procedures	can	allow	the	auditor	to	
    financial	data.                                 achieve	audit	objectives	more	efficiently	
iii		 easonableness	testing	–	the	analysis	         by	reducing	or	replacing	other	detailed	
    of 	accounts,	or	changes	in	accounts	           audit	testing.
    between	accounting	periods,	that	involves	   ¤	 The	effectiveness	of 	analytical	procedures	
    the	development	of 	a	model	to	form	            depends	on	the	auditor’s	understanding	
    an	expectation	based	on	financial	data,	        of 	the	entity	and	its	environment	and	
    non-financial	data,	or	both.	                   the	use	of 	professional	judgment;	
                                                    therefore,	analytical	procedures	should	be	
   Each	of 	the	types	uses	a	different	method	      performed	or	reviewed	by	senior	members	
to	form	an	expectation.	They	are	ranked	            of 	the	engagement	team.
from	lowest	to	highest	in	order	of 	their	       ¤	 It	is	vital	that	the	analytical	procedures	
inherent	precision.	Scanning	analytics	are	         be	sufficiently	documented	to	enable	an	
different	from	the	other	types	of 	analytical	      experienced	auditor,	having	no	previous	
procedures	in	that	scanning	analytics	              connection	with	the	audit,	to	understand	
search	within	accounts	or	other	entity	data	        the	work	done	(ISA/HKSA	230(8)).	
to	identify	anomalous	individual	items,	while	
the	other	types	use	aggregated	financial	        Charles Fung