Substantive Analytical Procedures

Article excerpt

SUBSTANTIVE ANALYTICAL PROCEDURES

A thorough understanding of analytical procedures is becoming more and more important to the effective and efficient performance of an audit. In this article, Ray Whittington, CPA, director of audit research at the American Institute of CPAs, New York, focuses on the use of analytical procedures in substantive testing, particularly when they're combined with tests of details for a particular assertion. Statement on Auditing Standards no. 56, Analytical Procedures, effective for audits of financial statements for periods beginning on or after January 1, 1989, makes analytical procedures a required part of the planning and overall review phases of an audit. It also says analytical procedures may be the most effective or efficient substantive procedures for obtaining evidence about certain financial statement assertions.

SAS no. 56 says an auditor can rely on substantive procedures to achieve an audit objective through tests of details, analytical procedures or a combination of both. The auditor's decision about the procedures to use depends on what is expected to be more effective and efficient. This is a two-step process. The auditor

1. Determines the overall level of assurance required from the substantive procedures, based on assessments of inherent and control risks.

2. Determines the appropriate mix of substantive tests (analytical procedures and tests of details) based on the nature of the assertion and the tradeoffs between the levels of assurance the tests provide and the time involved in performing them.

Substantive procedures. When performing substantive analytical procedures, the auditor develops an expectation about a current financial statement amount using other data--such as comparable prior years' amounts, industry statistics or budgeted amounts. The auditor then compares the expectation to the current amount and investigates any significant differences that resulted.

The most important consideration in determining the extent of the assurance obtained from an analytical procedure is the precision of the expectation. The more precise the current estimate, the more evidence is obtained from the analytical procedure.

In evaluating the precision of the estimate, SAS no. 56 says the auditor should consider the completeness of the data used to develop the expectation and the level of detail. Broad-level (for example, year-to-year numbers) expectations aren't generally as precise as expectations developed using more detailed (for example, monthly) data. Other factors affect precision, such as the reasonableness and predictability of the relationship between the current amount and the data used to make the prediction and the reliability or accuracy of the data. Therefore, the extent of the analytical procedures that can be performed largely depends on the data that are available to develop the expectations--a factor largely outside the control of the auditor. …