Analytical Procedure

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Analytical procedures have become increasingly important to audit firms and are now considered to be an integral part of the audit process. The importance of analytical procedures is demonstrated by the fact that the Auditing Standards Board, the board that establishes the standards for conducting financial statement audits, has required that analytical procedures be performed during all audits of financial statements. The Auditing Standards Board did so through the issuance of Statement on Auditing Standards (SAS) No. 56 in 1988, which requires that analytical procedures be used by auditors as they plan the audit and also in the final review of the financial statements. In addition, SAS No. 56 encourages auditors to use analytical procedures as one of the procedures they use to gather evidence related to account balances (referred to in auditing as a substantive test). The purpose of this article is to provide the reader with a general understanding of analytical procedures and to describe the process that auditors use in applying analytical procedures. SAS No. 56 describes analytical procedures as the "evaluation of financial information made by a study of plausible relationships among both financial and nonfinancial data" (AICPA, 1998, 56 p. 1). Accounting researchers have helped to clarify the process that auditors use to perform analytical procedures by developing models that describe the various stages of the process. One such model developed by Hirst and Koonce (1996) describes the performance of analytical procedures as consisting of five components: expectation development, explanation generation, information search and explanation evaluation, decision making, and documentation. Due to the importance of each of these five components to understanding the analytical procedures process, each of them is described in more detail. The first step in the analytical procedures process is the development of an expected account balance. SAS No. 56 and auditing textbooks (e.g., O'Reilly et al., 1998) provide some guidance as to the sources of information an auditor can use to develop these expectations. Examples of such sources include the following: * Financial information from comparable prior periods adjusted for any changes expected to affect the current-period balances. For example, an expectation of sales revenues for the current year might be based on the prior year's sales, adjusted for factors such as price increases or the known addition or loss of major customers. * Expected results based on budgets or forecasts prepared by the client or projections of expected results prepared by the auditor from interim periods or prior comparable periods. * Available information from the company's industry. For example, changes in sales revenue or gross margin percentages might be based on available data from industrywide statistics. * Nonfinancial information. For example, sales revenue for a client from the hotel industry might be based on available data as to room occupancy rates. After an auditor has developed an expectation for a particular account balance (e.g., sales revenue), the next step in the analytical procedures process is to compare the expected balance to the actual balance. If there is no significant difference (referred to by auditors as a material difference) between the expected and actual balance, this conclusion provides audit evidence in support of the account balance being examined. However, if there is a material difference between the expected and actual balance, the auditor will investigate this difference further. At this point the auditor will develop an explanation for the difference. Hirst and Koonce (1996) interviewed auditors from each of the six largest accounting firms and found that the source of the explanation usually depends on what types of analytical procedures are being performed. If analytical procedures are being performed during the planning phase of the audit, the...
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