Auditing standards define analytical procedures as “evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data.” Auditors use analytics to understand or test financial statement relationships or balances. Significant fluctuations or relationships that are materially inconsistent with other relevant information or that differ from expected values require additional investigation. Examples of analytical tests include trend and trend analysis, reasonableness testing, and regression analysis.
Using analytics in an audit
Experienced auditors use analytical procedures in all stages of the audit. For example, analytical procedures may help the auditor during the planning stage to determine the nature, timing and extent of auditing procedures that will be used to obtain audit evidence for specific account balances or classes of transactions.
Analytics also come into play at the end of the audit. Before delivering financial statements to the company being audited, auditors evaluate whether the overall financial statement presentation appears reasonable in the context of other financial and nonfinancial data.
During fieldwork, auditors may use analytical procedures, sometimes in combination with other substantive testing procedures, to obtain evidence that will help identify misstatements in account balances. This can help reduce the risk that misstatements will remain undetected. Analytical procedures are often more efficient than traditional testing procedures, which tend to require the company being audited to produce significant paperwork. Traditional procedures also typically require substantial time to verify account balances and transactions.
Establishing a threshold for additional procedures
When using analytical procedures, it’s critical for the auditor to establish a threshold that can be accepted without further investigation. This threshold is influenced primarily by the concept of materiality and the desired level of assurance. The threshold is typically lower when using analytics to perform substantive testing (where the risk of material misstatement is higher) than when using analytics in planning or final review.
Establishing the threshold for analytical procedures is a matter of the auditor’s professional judgment. The threshold should factor in the possibility that a combination of misstatements could aggregate to an unacceptable amount. For example, when analyzing expense accounts, an auditor may decide that it’s necessary to investigate the difference between what’s expected and what’s reported only if it exceeds the auditor’s expectation by 10% and/or $10,000. These amounts may vary from company to company and from year to year.
Discuss operational changes with your auditor
Done right, analytical procedures may help make your audit less time-consuming, less expensive and more effective at detecting errors and omissions. However, major business developments could affect 1) your auditor’s independent expectations about account balances or financial relationships, and 2) possible explanations for significant discrepancies between the auditor’s expectations and reported amounts. So, it’s important to let your auditor know about any changes to your operations, accounting methods or market conditions that happened in 2023.
Sidebar: 4 steps when applying audit analytics
When performing analytical procedures, auditors generally follow a four-step process:
- Form an expectation. The auditor develops an independent expectation of an account balance or financial relationship. Expectations are formed by identifying relationships based on the auditor’s understanding of the company and its industry. Examples of data that auditors use to develop their expectations include prior-period information (adjusted for expected changes), management’s budgets or forecasts, and ratios published in trade journals.
- Identify differences between expected and reported amounts. The auditor compares an expected amount with the amount recorded in the company’s accounting system. Then any difference is compared to the 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, the auditor moves on to the third step of the process.
- Investigate the source of the discrepancy. The auditor brainstorms all possible causes and then determines the most probable cause(s) for the discrepancy. Sometimes, the analytical test or the data itself is problematic, and the auditor needs to apply additional analytical procedures with more precise data. Other times, the discrepancy has a plausible explanation, usually related to business changes or unusual transactions or events. For example, if a retail business reports higher-than-expected revenue, it could be explained by a change in the product mix or the opening of a new store.
- Evaluate differences. The auditor evaluates the likelihood of material misstatement and then determines the nature and extent of any additional auditing procedures. Plausible explanations require corroborating audit evidence. For example, if a manufacturer’s gross margin seems too low, its CFO might explain that a key supplier increased the price of raw materials. To corroborate that explanation, the auditor might confirm the price increase with the supplier. Or, if an increase in cost of sales in one month was attributed to an unusually large sales contract, the auditor might examine supporting documentation, such as the sales contract and delivery dockets. In some cases, the auditor will conduct more in-depth testing than in previous years when analytical procedures reveal a major discrepancy.
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.
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