During the pandemic, many audit procedures have been performed remotely, forcing auditors to rely more heavily on analytical procedures, such as trend, ratio, and regression analysis, than in the past. But so-called “analytics” isn’t a novel concept for auditors. They’ve been using analytics for decades to make audits more efficient and effective.
The American Institute of Certified Public Accountants (AICPA) publishes guidance on using analytics during a financial statement audit. The auditing standards define 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.”
Auditors use analytics to understand or test financial statement relationships or balances. The type of procedures is customized, depending on the size and complexity of the company.
When performing analytics, auditors generally follow this five-step process:
- Form an independent expectation based on the company and its industry
- Identify differences between expected and reported amounts
- Brainstorm all possible causes for the discrepancy
- Determine the most probable cause(s) for the discrepancy
- Evaluate discrepancies to determine the nature and extent of any additional auditing procedures
Any discrepancy is compared to the auditor’s threshold for analytical testing. If the difference is less than the threshold, the auditor generally accepts the recorded amount without further investigation and the analytical procedure is complete. If the difference is greater than the threshold, additional procedures may be needed.
A closer look
Additional investigation is required for significant fluctuations or relationships that are materially inconsistent with other relevant information or that differ from expected values. For differences above the threshold, the auditor will likely inquire about the reason.
Many discrepancies have “plausible” explanations, usually related to unusual transactions or events or accounting or business changes. Plausible explanations typically require corroborating audit evidence. For example, if a manufacturer’s gross margin seems off, the accounting department might explain that its supplier increased the price of raw materials. To corroborate that explanation, the auditor might confirm the price increase with its top supplier.
In some cases, a discrepancy may warrant more in-depth testing. Other times, the analytical test or the data itself is problematic, and the auditor needs to apply additional analytical procedures with more precise data.
For differences that are due to misstatement (rather than a plausible explanation), the auditor must decide whether the misstatement is material (individually or in the aggregate). Material misstatements typically require adjustments to the amount reported and may also necessitate additional audit procedures to determine the scope of the misstatement.
Creating a paper trail
Auditors document analytical procedures in audit work papers. These are the files the auditor creates to support their audit conclusions. In general, work papers document the procedures applied, tests performed, information obtained, and conclusions reached in the audit.
For each analytical procedure performed during the audit, the work papers will explain the factors considered when developing the expectation and how the expectation compares to the recorded amounts or ratios developed from recorded amounts. The auditor also must document the results of any additional auditing procedures — such as management inquiry, research, and testing — performed in response to significant unexpected discrepancies.
Help us help you
Analytical procedures can help make your audit less time-consuming and more effective at detecting errors and omissions. You can facilitate these procedures by forewarning your auditors about any recent changes to the company’s operations, accounting methods, or market conditions. This insight can help auditors develop more reliable expectations for analytical testing and identify plausible explanations for significant changes from the balance reported in prior periods.
In addition, now that you understand the role analytical procedures play in an audit, you can anticipate audit inquiries, prepare explanations, and compile supporting documents before the start of audit fieldwork. Contact a member of your KraftCPAs audit team for more information.