Analytical review procedures are an essential component of the auditing process. Auditors use these techniques to analyze financial statement data and identify any unusual trends, ratios, or relationships that could indicate risks of misstatement or fraudulent reporting. This guide will provide a comprehensive overview of the analytical review.
What is an Analytical Review?
Analytical review is the technique used by auditors to obtain audit evidence supporting the validity, completeness, and accuracy of accounting records and financial statements.
Analytical review involves the analysis of financial information by studying plausibility relationships among both financial and non-financial data. It enables auditors to identify fluctuations and inconsistencies that could signify inaccurate or incomplete financial reporting.
Specifically, auditors compare current period account balances and financial ratios to expected amounts based on past trends, industry benchmarks, budgeted performance, and an understanding of the client’s business. Significant deviations from the expected amounts are investigated further.
Core Objectives of Analytical Review
Analytical review procedures aim to achieve the following key objectives:
- Identify potential material misstatements in financial statement accounts
- Assess and highlight areas of high risk to focus substantive audit testing
- Corroborate the conclusions drawn from other audit testing
- Provide an overall reasonableness check on the financial statements
- Enhance audit efficiency by directing efforts at high risk areas
- Evaluate the possibility of fraudulent activities
Examples of Analytical Tests
- Compare revenue growth year-over-year to identify unusual spikes or dips.
- Review gross profit ratio trends to detect unexplained deterioration.
- Verify totals of inventory sub-ledger tie back to the general ledger balance.
- Assess whether executive compensation appears in line with industry standards.
Benefits of Analytical Procedures
- Identify high risk areas to focus substantive testing on.
- Corroborate other audit evidence and conclusions.
- Provide overall reasonableness check on financial statements.
- Help assess potential fraud risks.
- Enable more efficient audits focused on high risk areas.
When Are Analytical Procedures Performed?
Auditors perform analytical procedures during three main phases of the audit:
1. Planning Stage
Initial analytical tests help auditors gain understanding of the client’s operations and identfy risks. This guides audit planning.
2. Substantive Testing
Analytical tests supplement other substantive tests done to validate account balances.
3. Final Review
Final analytical review evaluates whether audit evidence supports the financial statements as a whole.
Types of Analytical Review Procedures
1. Trend Analysis
Compares changes in accounts over time to identify anomalies and significant fluctuations.
2. Ratio Analysis
Assesses financial ratios like gross margin, assessing unusual variances.
3. Reasonableness Testing
Validates whether balances make intuitive sense based on logic and expectations.
4. Predictive Analytics
Statistical techniques and modeling to predict expected account amounts.
5. Industry Comparison
Compares client ratios to industry benchmarks and competitor data.
6. Regression Analysis
Models the relationship between financial and non-financial variables to identify outliers.
Designing Effective Analytical Tests
Auditors consider several factors when designing effective analytical procedures:
- Level of Disaggregation – More granular data improves insights but requires more effort.
- Reliability of Data – Tests depend on accuracy and completeness of underlying data.
- Plausibility – Focus on trends and ratios with logical relationships.
- Thresholds – Determine materiality thresholds for investigating variances.
- Precision – Balancing precision of expectations with effort required.
Investigation of Significant Variances
Unusual fluctuations or ratios identified through analytical review are investigated through inquiry with management and corroborating evidence. Auditors must understand the underlying cause and determine if it represents a risk of misstatement.
Conclusion
In summary, analytical review encompasses a variety of powerful procedures that provide invaluable audit evidence. Properly designed and executed analytical tests can improve audit quality, highlight risk areas, and complement other substantive procedures. Auditors rely heavily on these techniques to conduct efficient, risk-focused audits.