Analytical Procedures
Analytical Procedures in Audit
In audit Analytical Procedures that seek to provide evidence as to the completeness, accuracy, and validity of the information contained in the accounting records or in the financial statements.
Analytical Procedures consists of the systematic study and comparison of relationships among elements of financial information and the investigation of significant fluctuations and variances from the expected relationship
Steps involved in analytical procedures
- Expectation: This step involves developing an expectation of what the financial information figures should be. This can be agreed upon through comparisons of financial information or considerations of relationships (ratio analysis).
- Identification: This step involves the identification of significant variations between the actual data with the expected data.
- Investigation of unusual variances: Once the variation has been computed, and if significant variations are found, the auditor would consult the management in order to establish explanations for the variations revealed.
- Performance of alternate procedures: If the auditor or the management does not find the variation reasonable, then they investigate further and perform analytical procedures to satisfy themselves.
When performing an analytical procedure, the auditor compares numbers, ratios or even non-financial information in order to identify unexpected trends or unexpected relationships, which may indicate the existence of errors.
There are many different analytical procedures including the comparisons listed below
- Year on year (e.g. revenue this year compared to revenue last year);
- To budget or forecast (e.g. actual purchases compared to budgeted purchases);
- To predictions made by the auditors-proof in total (e.g. auditor’s calculation of depreciation compared to the client’s calculation);
- Through industry information (e.g. client’s revenue compared to competitor’s revenue).
- Comparison/analysis of relationships between different elements of the financial statements ( for example gross profit compared to sales)
- Comparison of financial info with non-financial info ( for e.g. payroll expense matched to the number of employees)
- Non-financial information. For Example, sales revenue for a client from the hotel industry may be available data as to room occupancy rates basis.
| Analytical Procedures at the Planning stage | To assist the auditor in the planning stage the nature, timing, and extent of other audit procedures. Use at this stage should add to the firm’s understanding of the business and identify the risky areas in which audit resources should be targeted. |
| Analytical Procedures at substantive testing stage | at the detailed testing stage – in most instances analytical procedures should be used in conjunction with tests of detail to achieve a particular audit the objective in relation to specific financial statement assertions.. |
| Analytical Procedures at the Review stage | At the final review stage the the auditor must design and perform analytical procedures that assist him when forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity and that all of the audit objectives with regard to the financial statements have been met. |
Using Ratios
In the Paper Audit and Assurance exam, you may be asked to compute and interpret the key ratios used in analytical procedures at both the audit planning stage and when collecting audit evidence. Ratios and comparisons can be used to identify where the accounts can be wrong, and where additional auditing effort needs to be spent.
Ratio’s
Ratio Analysis Plays a key Roll to determine the business circumstance, here are a few Ratios are given below.
In the examination, you will be asked to calculate and interpret the ratios used in analytical procedures at the audit planning stage and when collecting audit evidence. Ratios and comparisons can be used to identify where the accounts might be wrong or right, and where additional auditing effort should be a need to spend.
Calculating a ratio is an easy step, divide a number by another number, the calculations are so basic that they can be calculated using a spreadsheet.
The real skill is the interpretation of results and using that information to conduct out a better audit. Saying that a ratio has increased because the top line in the calculation has increased or the bottom line decreased is rather had no point, this is simply translating the calculation into words. the interpretation is another thing.
Gross Profit Margin: Gross profit/Sales Revenue x 100
Operating profit margin =Operating profit/Sales Revenue x 100
Return on capital employed (ROI) = Operating profit/ Capital employed x 100
Current Ratio= Current Assets/Current Liabilities
Quick ( or asset test) ratios =Current assets minus inventory/ current liabilities
Inventory holding period or Inventory days =Inventory/Cost of sales x 365
Receivable days/ Receivables collection period =Trade receivables/Sales x 365
Trade payable Days/Payables payment period =Trade payables/Cost of sales x 365
Interest cover = profit before interest/ interest
| Gearing = Long-term loan finance/ equity finance x 100 The gearing ratio can also be defined in other words, particularly by comparing long-term loan finance to total finance. As the gearing ratio increases so risk that the interest can’t be paid. But it is difficult to define a ‘safe’ level of gearing. an example is , a property company with properties leased to tenants will have a fairly rental income for one year. Such a company can probably safely sustain substantial borrowings (though it could be in trouble if interest rates increased significantly). A company with volatile streams of income would have to keep its gearing lower as it must ensure that they have the ability to pay interest during the lean times. |
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