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These tests point out potential problems and help auditors take steps to resolve them. In this article, we discuss analytical procedures in accounting and list seven types and examples of analytical procedures auditors use to confirm the precision of figures and calculations. Analytical procedures are also required during the completion phase of the audit.

But, to avoid surprises in the coming audit season, notify your auditor about any major changes to your operations, accounting methods or market conditions that occurred in 2017. The auditor must compare his or her expectation with the amount recorded in the company’s accounting system. Then any difference is compared to the auditor’s threshold for analytical testing. If the difference is less than the threshold, preliminary analytical procedures examples 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 next step is to investigate the source of the discrepancy. Auditors use regression analysis to determine how two sets of variables relate to each other. This type of analysis requires the dependence of one variable on the other.

What is the Importance of Analytical Procedures in Auditing?

The company is a niche provider in the overall hardware industry, which is dominated by national chains like Home Depot and Lowe’s. Hillsburg’s auditors identified potential increased compe – tition from national chains as a specific client business risk. https://online-accounting.net/ Hillsburg’s market consists of smaller, indepen dent hardware stores. Increased competition could affect the sales and profitability of these customers, likely affecting Hillsburg’s sales and the value of assets such as accounts receivable and inventory.

Auditors also use another type of ratio analysis, called industry comparison, to examine these ratios. This process involves the calculation of the same ratios for companies in the same industry to ensure their client’s values are similar or higher than other companies. Brian compared his clients’ assets and liabilities for the most recent fiscal year with those reported by his clients during the five years prior. The first client’s liabilities and assets followed the trend established during the previous years, so Brian confirmed that these aspects of the company’s finances remained stable. When analyzing his second client, he noticed a significant change in their assets and liabilities from previous years.

Examples of Analytical Procedures Related to Revenue Accounts

During this process, if auditors identify any anomalies, they will need to perform a risk assessment. This assessment will help them establish whether they need to perform any further auditor procedures.

Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs.

Analytical Procedures in Auditing: Definition and Its Importance

More complex analytical techniques that have crept into modern auditing, primarily in larger audit environments, are beyond the scope of this article. Auditors can also use analytical procedures as a part of the substantive tests that they carry out. It may also include test of details or a combination of both. Usually, auditors have to use their professional judgment to establish what procedure to use.

Must identify related parties and make a reasonable effort to determine that all material related party transactions have been properly disclosed in the financial statements. Analysis of the current year financial information with the prior years’ data can also be effective in discerning potential audit problems. Suppose your company has had stable gross margins in the last several years, and this year’s margin has increased significantly. The analytical review procedure would reveal this change, and the auditor would need to investigate the cause of the increased gross margin. There is a direct correlation between the predictability of the data and the quality of the expectation derived from the data. Generally, the more precise an expectation is for an analytical procedure, the greater will be the potential reliability of that procedure.

Audit planning level

Other metrics such as earnings before interest, taxes, depreciation, and amortization are consequential for some companies. Do you expect sales to decrease 5% based on decreases in the last two years? If yes, then an increase of 15% is a flashing light. Knowing what to expect provides a basis for understanding the changes in numbers from year to year. This technique determines the debt load the business has incurred. This method determines the ability of a company to cover its debts.

• For instance, all accounts with changes of greater than $30,000.
• Calculating the interest expense on a long term notes payable.
• Finally, budget expectations or other calculated predictive tests, such as interest expense from an amortization schedule, can be factored in and compared to the trend analysis and industry data.
• The auditor investigates any unusual or unexpected variation from expected results the analytical procedures reveal.

It is to be expected that any company will have variances from industry trends. The value of the comparison is in identifying those variances and understanding their underlying causes. The article considers ratings of banks’ reliability.

Final analytical review procedures-FAR

Using this, auditors can determine how one variable affects the other over an established time period. They can then use this information to predict certain financial elements, such as account balances.