Efficient Tests of Balances Series—No. 8: Using Highly-Effective Analytical Procedures

Analytical procedures consist of absolute comparisons of dollar balances with prior years’ account balances, or with budgets, ratio comparisons and trend analysis, and computations based on financial or operational data designed to predict the balance in a general ledger account.  Analytical procedures also extend beyond numerically-based procedures to become a part of an auditor’s thought process.  

Challenging financial information or the lack of such information that appears unusual, maintaining a positive, healthy skepticism when considering client responses to inquiries, and searching for the cause of a problem beyond its symptoms are examples of analytical thinking.  The term “professional skepticism” is used in the audit literature to describe this kind of thinking.  It is loosely defined as neither blindly trusting every client or, on the other hand, considering each client dishonest as we gather information.

Most common analytical procedures are corroborative in their nature.  Their primary purpose is to corroborate evidence gathered from other tests designed to verify financial statement assertions.  Corroborating procedures performed at lower levels of detail are more effective than corroborating procedures based on balances of financial statement classifications.

When the results of analytical procedures contribute evidence to verify financial statement assertions, related tests of balances can be reduced at least to a limited extent.
The extent of the reductions of tests of balances depends on the effectiveness of the analytical procedures.  Determination of the effectiveness of a procedure must be based on the procedure’s contribution of substantive evidence for evaluating the financial statement assertions.  Computations designed to predict the balance in a general ledger account based on audited financial or operational data, e.g. quantity reconciliations and reasonableness tests, are normally the most effective analytical procedures.
 
Examples of analytical procedures, in the order of their effectiveness, are:

1.  Quantity reconciliations:

Multiplying the number of units sold times sales price or the number of employees times weekly or monthly salaries, for example, can substantially verify all the financial statement assertions for the applicable general ledger account.  Few, if any, other tests would be necessary for the affected accounts if the data used in the computations has been audited.

To achieve maximum effectiveness, the reliability of the underlying data for these procedures must be established by other tests.  For example, performing a quantity reconciliation for copy sales by a quick-copy business would simply require multiplying the number of copies sold times sales price.  The number of copies could be obtained from the client’s copy log; however, we’d have to physically obtain beginning and ending numbers from the meter to establish the reliability of the log.  To determine the meter had not been altered, we may also decide to trace the number of copies to billings for copy machine rentals from the supplier.  Copy prices would have to be determined by references to sales tickets or price lists.

2. Reasonableness tests:

Depreciation computations performed by computing depreciation by financial statement classification and method, based on average lives and one-half year for additions and disposals, is an example of a reasonableness test.  Computing interest expense based on average note balances and interest rates is another example.

Different from quantity reconciliations, reasonableness tests are based on averages and estimates.  Reasonableness tests are, therefore, not as effective as quantity reconciliations in substantially verifying financial statement assertions.  Since they are usually applied to smaller account balances, however, other tests of balances may not be necessary.  Other limited tests of controls or balances, on the other hand, may be necessary to complete the verification of the relevant assertions for material balances.

3.  Corroborating procedures:

The most common analytical procedures, such as absolute dollar comparisons and ratio analysis, provide evidence that corroborates other tests of controls and balances.  While using corroborating analytical procedures may enable us to modify the nature, extent and timing of tests of balances procedures, certain minimum tests of balances procedures will be necessary for satisfactory verification of the financial statement assertions.

The lower the level of detail of the corroborating procedures, the more effective they are.  Gross profit margin computed by product line, for example, is more effective than when computed using amounts in financial statement classifications.  Risks of material misstatements, in other words, are more easily identified using corroborating procedures at lower levels of detail.

The current risk assessment standards instruct us to perform analytical procedures during the planning phase of an engagement to help identify potential risks of misstatements.  Analytical procedures should also be used to generate substantive evidence during engagement performance and during the review phase of an engagement to evaluate the results of completed work.

Minimum analytical procedures performed during planning may consist of comparing material unadjusted, current year account balances with prior year final balances.  Significant variances usually indicate the need for adjusting journal entries.  These differences should be investigated, documented in the working papers and, if necessary, adjustments proposed to correct errors.  

When corroborating or predictive procedures are part of an audit strategy, the auditor must develop and document expectations of the results prior to performing the procedures. From the comparison of the expectations to recorded balances, the auditor may determine that variances are not indicative of a problem or, on the other hand, that they are caused by an error or conditions that could cause errors in financial information.  We may, or may not, determine adjustments are necessary.

I have developed an illustrative Analytical Procedures Program to support my live and on-demand webcasts which illustrates some of the common types of analytical procedures applicable to material financial statement classifications, and the planning process that should guide their use. If you’d like a free copy please make your request under the “Contact Us” tab on my website, www.cpafirmsupport.com.

This blog

by Larry Perry, CPA, CPA Firm Support Services, LLC - Larry has over 40 years experience as a CPA practitioner, author of accounting and auditing manuals, author and presenter of live staff training seminars and author of webcast and self-study CPE programs.  He is co-founder of CPA Firm Support Services, LLC (www.cpafirmsupport.com), an organization providing resources, training and consulting to smaller CPA firms.  Larry writes a weekly blog on AccountingWEB.com focusing on small audits, reviews and compilations.  He is currently developing documentation manuals and handbooks for small audits, reviews and compilations and related electronic practice aids.

More from this blog

Bloggers crew

Steve Knowles has spent 25 years in business and practice in the UK, but he also worked in the states and the years haven't dulled his way of seeing an alternative view to everyone else, and every day is a new adventure.

44739

Joel M. Ungar, CPA is a lifelong resident of the Detroit area and a graduate of The University of Michigan. He is a principal with Silberstein Ungar, PLLC, a Top 15 auditor of SEC public reporting companies.

77358

Allan Boress, CPA, with over 25 years as a practitioner and consultant to the accounting profession. Mr. Boress is the author of 12 published books in 6 different languages, including a best-seller, The "I-Hate-Selling" Book.

49730

Larry Perry, CPA, CPA Firm Support Services, LLC, is the author of accounting and auditing manuals, author and presenter of live staff training seminars, and author of webcast and self-study CPE programs. He blogs about small audits, reviews, and compilations.

90943
Sandra Wiley, COO and Shareholder, is ranked by Accounting Today as one of the 100 Most Influential People in Accounting as a result of her prominent role as an industry expert on HR and training as well as influence as a management and planning consultant. She is also a founding member of The CPA Consultant's Alliance. Sandra is a certified Kolbe™ trainer who advises firms on building balanced teams, managing employee conflict and hiring staff.
21628

Maria Calabrese, CIR, Human Resources manager for Fazio, Mannuzza, Roche, Tankel, LaPilusa, LLC in Cranford, New Jersey, Maria's topics revolve around the world of: Mentoring, Performance management, and The "Y Generation," a.k.a. "The whY generation".

56992

William Brighenti is a CPA, Certified QuickBooks ProAdvisor, and Certified [Business] Valuation Analyst, operating an accounting, tax, and QuickBooks consulting firm in Hartford, Connecticut, Accountants CPA Hartford.

82168

Ken Garen, CPA, is the co-founder and President of Universal Business Computing Company (www.ubcc.com), a software development firm of high-volume, high-productivity accounting and payroll technology.

25813

Eva Rosenberg, MBA, EA, is the publisher of TaxMama.com, and author of the weekly syndicated Ask TaxMama column. She provides answers to tax questions from taxpayers and tax professionals worldwide.

65553

Amy Vetter, CPA, CITP is the CPA Programs Leader for Intacct Corporation responsible for leading the CPA/BPO Partners nationally.

35306
Brian Strahle is the owner of LEVERAGE SALT, LLC where he provides state and local tax technical services to accounting firms, law firms and tax research organizations across the United States. He also writes a weekly column in Tax Analysts State tax Notes entitled, "The SALT Effect." For more info, visit his website: www.leveragestateandlocaltax.com
104398
Scott H. Cytron, ABC, is president of Cytron and Company, known for helping companies and organizations improve their bottom line through a hybrid of strategic public relations, communications, marketing programs and top-notch client service. An accredited consultant, Scott works with companies, organizations and individuals in professional services (accounting, finance, medical, legal, engineering), high-tech and B2B/B2C product/service sales.
26973

Rita Keller is a nationally known CPA firm management consultant, speaker, author, mentor and blogger. She has over 30 years hands-on experience in CPA firm management, marketing, technology and administrative operations.

53917
Stacy Kildal is the mom of two fantastic kids, an Advanced Certified QuickBooks ProAdvisor, Certified Enterprise Solutions ProAdvisor, Sleeter Group Certified Consultant, a nationally recognized member of the Intuit Trainer and Writer Network, and co-host of RadioFree QuickBooks.
28892
Michael Alter's blog specializes in providing practical advice to those who seek greater profitability and practice management tactics that enhance deeper client relationships.
33256

Sally Glick, CMO, Principal, Marketer of the Year in 2003 and AAM Hall of Famer in 2007, leads a lively discussion of the constantly expanding roles of marketing and the professional marketers that drive this initiative in accounting firms of all sizes.

102340

The IMA Young Professionals Blog features the insights of IMA’s Young Professionals Committee. Committee members share advice and experiences on careers, continuing education, work/life balance, and other issues affecting young accounting and finance professionals.

34569

FEI Financial Reporting Blog provides highlights from SEC, PCAOB, FASB, IASB, and other regulatory news, including reporting under Sarbanes-Oxley Sect 404. It is written by Edith Orenstein, Director of Technical Policy Analysis at FEI.

113427

Sue Anderson has 30 years of experience in continuing education for accountants. Currently she is the program director for online CPE provider CPE Link.

62482

Jim Fahey is COO of Apple Growth Partners, a regional CPA firm in Ohio. His focus is on the effective and efficient use of technology within the firm by all team members.

40609
Caleb Newquist is the Editor-in-Chief of Sift Media US, overseeing content for both AccountingWEB and Going Concern.
67656

Leita Hart-Fanta, CPA, CGFM, and CGAP is the author of "The Yellow Book Interpreted" and owner of Yellowbook-CPE.com a website devoted to training for governmental auditors.

93759

AccountingWEB is more than just a U.S. team of journalists and financial and technology experts - we have an international side, too! Members of our British team who publish AccountingWEB.co.uk share their ideas, insights, and perspectives from across the pond.

54837