Analytical Procedures – A Powerful Tool for Auditors
(Relevant to Paper 8 – Principles of Auditing and Management Information Systems) David Chow FCCA, FCPA, CPA (Practising)
Auditors normally carry out the following types of audit tests to determine whether financial statements are fairly stated: (i) procedures to obtain an understanding of internal control (ii) tests of controls (iii) substantive tests: • substantivetestsoftransactions; • analyticalprocedures;and • testsofdetailsofbalances.
assessment of risks of material misstatement at the assertion level includes an expectation that controls are operating effectively. This means that auditors perform tests of controls only when: (i) a system exists; and (ii) the system has controls. The performance of tests of controls is to establish whether those controls in the systems are actually functioning properly and effectively so that the auditors can determine whether or not they can rely upon the controls. Substantive tests Substantive tests (also known as substantive procedures) are procedures designed to test for dollar errors or irregularities directly affecting thecorrectnessoffinancialstatementbalances. Auditors perform substantive tests in an audit to detect material misstatement at the assertion level. Substantive tests of transactions emphasize theverificationoftransactionsrecordedinthe journalsandthenpostedinthegeneralledger. Analytical procedures emphasize the overall reasonableness of transactions and the general ledger balances.Tests of details of balances consider the closing balances in the general ledger.
Auditors perform types (i) and (ii) audit tests to reduce assessed control risk, whereas substantive tests are used to reduce planned detection risk. There are three types of substantive test: substantive tests of transactions, analytical procedures, and tests of detailsofbalances. Auditors perform audit procedures (see below) in the form of detailed audit steps so as to achievethespecificauditobjectives.Indeedall audit procedures fall into any one of the five types of tests, and some of them may serve as morethanonetypeoftest. Tests of controls Auditors perform tests of controls when their
T/Dialogue April 2009
Relationship between tests of controls and substantive tests In tests of controls, an exception is only an indication of the likelihood of errors or irregularities affecting the dollar value of the financial statements, whereas an exception in substantive tests is a financial statement misstatement. Exceptions in tests of controls aresignificantonlyiftheyoccurwithsufficient frequency to cause the auditors to believe that there may be material dollar misstatements in thefinancialstatements.Auditorswould then need to plan to perform substantive tests to determine whether dollar misstatements have actuallyoccurred. Bright readers may have noticed that analytical procedures serve as both audit tests and audit procedure. Let’s study the roles of analytical proceduresinanaudit. Analytical procedures refers to the analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or which deviate from predictedamounts. Nature of analytical procedures T h e s e m a y b e a c h i e v e d t h r o u g h t h e consideration of comparisons of the entity’s financialinformationwith,forexample: • Comparableinformationforpriorperiods Auditors utilize the following types of audit procedures to collect audit evidence: (i) (ii) (iii) (v) (vi) inspection observation inquiry recalculation re-performance • Theentity’santicipatedresults • Similarindustryinformation. When performing analytical procedures, the auditors examine both financial data and nonfinancial...