1. ANALYTICAL PROCEDURES SECTION 7

2. What Are Analytical Procedures?
Evaluations of financial information made by a study of plausible relationships among financial and non-financial data
Where used?
Planning
Substantive tests
Overall review

3. Source of Expected Amount
Analytical involve comparisons of recorded amounts or ratios to expected amounts
Expected amounts developed from a variety of sources
Source of Expected Amount
Example
Financial information from prior periods
Anticipated results, such as budgets or forecasts
Relationships of elements of financial information within the period
Similar information regarding the industry in which the entity operates

4. Nature of Analytical Procedures
Three common types:
Trend analysis: The analysis of the change of an acount over time
Ratio analysis: A comparison of relationships among financial statement accounts
Reasonableness Tests: Computations usually involving non-financial data used to estimate an account balance

5. Trend Analysis Most common approach
By analyzing changes in an account balance over past accounting periods
The causal approach
Requires auditor to develop expected results
The diagnostic approach
Compare the current amount to the trend to see if the current amount appears to be acceptable

6. Diagnostic Approach Example
200Y
Change
% Change
Expected
Explanation
Sales
1,000,000
1,115,000
115,000
11.50
4.00 1
Cost of Sales
700,000
772,000
72,000
10.29 2
Depreciation
80,000
92,000
12,000
15.00 3
Sales commissions
50,000
66,000
16,000
32.00 4
Office Supplies
10,000
10,400
400 5
Advertising
8,000
8,320
320
Interest Expense
4,000
(66.70) 6
Utilities Expense
2,000
20.00 7
R & M Expense
3,000
3,100
100
3.30
Client bought new store on line in November
Increased sales due to new store
Client uses straight line. New store increased fixed asset base.
Increase % of sales commissions OK
Paid off debt
Added store location

7. Simple Trend Analysis
Involves determining an expected amount based on the account balance in prior periods
E.g. A company may have an average annual increase in sales revenue of 10%
What could be the cause if current years sales did not increase by 10%?

8. Regression Analysis
Sales revenues can be affected by a variety of factors
Can incorporate a number of variables
Best fit technique

9. Job Order Costing
Observation
Direct Labour Hours
Production Cost ($) 1
501
38,340 2
220
33,600 3
850
44,150 4
999
46,010 5
101
32,082 6 60
30,100 7
650
40,750 8
460
37,650 9
830
43,800 10
399
36,600 11
815
43,560 12
540
40,100

10. 46,640 x
45,560 x x x
42,480 x
40,400 x
38,320 x x x
36,240
34,160 x
32,080 x x
30,000
200
400
600
800
1,000

11. What would be the expected job cost?
From the graph
Y = 30, X
Job # 876 uses 962 DLH
What would be the expected job cost?
But if Job # 876 only cost $42,000
Why?

12. Ratio Analysis Compares relationships among account balances
Useful for both income and balance sheet
Effective for income statement accounts because it typically compares the variations in operating activity

13. Time Series Analysis
Ratios for an entity compared over time
Cross-Sectional Analysis
Ratios compared at a given point in time

14. Accounts Receivable Turnover Ratio
Firm A
Firm B
Firm C
Firm D
Industry Average
1997
3.5
3.0
3.8
1998
3.4
2.9
3.9
3.6
1999
3.2
2000
3.3
2001
2002
3.7
2003
2004
3.1
Cross Sectional Analysis
Time Series Analysis

15. Methods of Ratio Analysis Financial ratios and common size statements
Analyzes relationships among account balances that the auditor expects to:
Remain stable over time
Be common across firms

16. Common-Size Statements
In preparing common-size statement, the auditor converts the dollar amount of each account balance to a percentage of some relevant aggregate amount
Time-series or cross-sectional
Generally more useful for income statement accounts

17. Common-Size Income Statement
200B
200C
200D
Revenues
Sales
102.0
102.9
104.0
103.1
Sales returns
2.0
2.9
4.0
3.1
Net sales
100.0
10.0
Expenses
Cost of sales
41.1
40.8
39.9
40.4
General, selling, and Admin.
21.3
22.4
23.4
23.3
Interest
18.1
18.8
19.4
20.0
Other
5.2
4.6
3.8
1.8
Tax
5.4
5.3
5.1
Income after tax
8.9
8.1
8.4
9.1

18. Use of Industry Ratios
When performing cross-sectional analysis the auditor may use industry ratios
Dun and Bradstreet
840 different classifications

19. Limitations in Using Ratio Analysis
Different accounting principles can make financial ratios non-comparable
Ratios may differ among entities depending upon individual differences
Auditor should exercise caution when comparing the client with the industry

20. Reasonableness Tests
Computations that calculate an expected amount by using operating data
What could one use if trying to estimate passenger revenue for a bus company or an airline?
How about total room revenue for a hotel?

21. One period model
Reasonableness tests typically involve operating data which measures flow over time
Can sometimes be excellent for the completeness assertion
E.g. Expected revenues for an electrical utility

22. Timing of Analytical Procedures
Three phases of an audit:
Planning
Fieldwork; and
Final review
The purpose of the analytical procedure depends on the audit phase

23. Planning
Analytical procedures can draw attention to audit areas with significant potential for misstatement
They can also enhance understanding of the client’s operations, transactions, and events
The sophistication of the procedure can vary widely depending on the size and complexity of the client
Determining risk

24. Fieldwork Used for substantive testing
For a test of transactions an balances for inventory, what type of procedures can we use?
How can an analytical procedures supply supporting or corroborating data for accounts receivable?

25. Final Review
Analytical procedures are used in the overall or final review stage of the audit to assist the auditor in assessing
The adequacy of substantive tests.
The sufficiency of evidence
The validity of conclusions reached
Should be performed by a person with in-depth knowledge

26. Reliability of Data Used to Develop Expectations
More reliable if
From an independent source
Maintained by people not in a position to manipulate relevant accounting records
Derived from an adequate internal control structure
Subjected to audit testing in a prior year