Analytical Procedures in an Audit

By CPABC
Last Revision: 10/20/2016

Analytical procedures are of extreme importance to an auditor.  Firstly, they are required procedures under Canadian Auditing Standards (CAS).  Secondly, they can help an audit be both more efficient and effective when compared to test of details such as sampling.  The principal CAS standard that provides guidance on the nature and use of analytical procedures is CAS 520 Analytical Procedures.  CAS 520.4 defines analytical procedures as:

Evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.

There are various methods that may be used to perform analytical procedures. The methods range from performing simple year over year comparisons of balances, transaction streams or ratios to performing complex analyses using advanced statistical techniques. The level of audit evidence obtained from analytical procedures is directly tied to their sophistication.  In other words, the more complete the analysis the more persuasive the audit evidence.

Under CAS there are three general categories of analytical procedures, those used as a risk assessment procedure, substantive analytical procedures, and those that assist when forming an overall conclusion.

Risk Assessment Procedures

As the CAS are a fundamentally a risk based approach to auditing CAS 315 Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and its Environment is in many ways the cornerstone standard within the CAS.  CAS 315.6 requires the auditor to include analytical procedures as part of their risk assessment procedures.  The guidance for this type of analysis is included in CAS 315.A14-A17:

CAS 315.A14

Analytical procedures performed as risk assessment procedures may identify aspects of the entity of which the auditor was unaware and may assist in assessing the risks of material misstatement in order to provide a basis for designing and implementing responses to the assessed risks. Analytical procedures performed as risk assessment procedures may include both financial and non-financial information, for example, the relationship between sales and square footage of selling space or volume of goods sold.

CAS 315.A15

Analytical procedures may help identify the existence of unusual transactions or events, and amounts, ratios, and trends that might indicate matters that have audit implications. Unusual or unexpected relationships that are identified may assist the auditor in identifying risks of material misstatement, especially risks of material misstatement due to fraud.

CAS 315.A16

However, when such analytical procedures use data aggregated at a high level (which may be the situation with analytical procedures performed as risk assessment procedures), the results of those analytical procedures only provide a broad initial indication about whether a material misstatement may exist. Accordingly, in such cases, consideration of other information that has been gathered when identifying the risks of material misstatement together with the results of such analytical procedures may assist the auditor in understanding and evaluating the results of the analytical procedures.

CAS 315.A17

Some smaller entities may not have interim or monthly financial information that can be used for purposes of analytical procedures. In these circumstances, although the auditor may be able to perform limited analytical procedures for purposes of planning the audit or obtain some information through inquiry, the auditor may need to plan to perform analytical procedures to identify and assess the risks of material misstatement when an early draft of the entity's financial statements is available.

Substantive Analytical Procedures

The substantive procedures used by an auditor may include tests of details, substantive analytical procedures, or a combination of both. Ultimately, the determination of which procedures to perform, including whether to use substantive analytical procedures, is based on the expected effectiveness and efficiency of the available audit procedures to reduce audit risk at the assertion level to an acceptably low level.  In other words, there is no specific requirement under the CAS for the auditor to use substantive analytical procedures.  However, when applied appropriately they will often provide better audit evidence then do tests of detail and in many instances are also more efficient than tests of detail.

In general, there are four factors to consider when choosing to use an analytical procedure over another form of audit evidence.  Those factors are:

  1. The existence of a plausible and predictable relationship between financial and non-financial data;
  2. The nature of the assertion being addressed;
  3. The reliability of the data used to develop the expectation; and
  4. The precision of the expectation.

CAS 520.5 provides guidance for when the auditor decides to use substantive analytical procedures:

CAS 520.5

When designing and performing substantive analytical procedures, either alone or in combination with tests of details, as substantive procedures in accordance with CAS 330, 3 the auditor shall:

  1. Determine the suitability of particular substantive analytical procedures for given assertions, taking account of the assessed risks of material misstatement and tests of details, if any, for these assertions;
     
  2. Evaluate the reliability of data from which the auditor's expectation of recorded amounts or ratios is developed, taking account of source, comparability, and nature and relevance of information available, and controls over preparation;
     
  3. Develop an expectation of recorded amounts or ratios and evaluate whether the expectation is sufficiently precise to identify a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated; and
     
  4. Determine the amount of any difference of recorded amounts from expected values that is acceptable without further investigation as required by paragraph 7.

Analytical Procedures that Assist When Forming an Overall Conclusion

The third category of analytical procedures are used near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity.  These procedures are a required by CAS 520 paragraph 6 as part of the audit and are often similar to the procedures used at the risk assessment stage.  CAS 520.A17-19 provides guidance on these final analytics:


CAS 520.A17

The conclusions drawn from the results of analytical procedures designed and performed in accordance with paragraph 6 are intended to corroborate conclusions formed during the audit of individual components or elements of the financial statements. This assists the auditor to draw reasonable conclusions on which to base the auditor's opinion.

CAS 520.A18

The results of such analytical procedures may identify a previously unrecognized risk of material misstatement. In such circumstances, CAS 315 requires the auditor to revise the auditor's assessment of the risks of material misstatement and modify the further planned audit procedures accordingly

CAS 520.A19

The analytical procedures performed in accordance with paragraph 6 may be similar to those that would be used as risk assessment procedures.