Good Error Analysis--A Key to Audit Quality

Good error analysis should be performed when an auditor evaluates the results of specific auditing procedures.  It should contain both quantitative and qualitative analysis by the person performing the work. The comparison of aggregated known and likely error to tolerable misstatement by financial statement classification (normally performed by the in-charge accountant) may indicate, however, the need for additional analysis when aggregated error exceeds tolerable misstatement.  It is possible that additional auditing procedures may even be necessary to reduce detection risk to an acceptable low level.

Aggregated known and likely error should also be compared with the totals of material financial statement classifications (such as current assets, current liabilities, equity, revenues, expenses, net income, etc.) to determine if the level of known and likely error is acceptable.  Some call this accounting materiality, i.e., evaluating aggregated uncorrected audit differences and likely error as a percentage of the financial statement classifications.  Acceptable percentages of known and likely error will vary according to risk at the financial statement and assertion levels.  Ultimately, the auditor will make these final materiality decisions based on how the user of the financial statements would evaluate the level of error.  After appropriate qualitative error analysis has been performed, the auditor may propose general journal entries to correct certain known errors that have a material effect, individually or in the aggregate, on financial statement classifications.

Common acceptable percentages of error may be 1-2% of assets, liabilities, revenues and expenses and 5% for equity and net income; however, these percentages may vary depending on the use of the financial statements.  The higher the risk associated with the use of statements, the lower are the acceptable percentages.

Contrary to the practices of some auditors, the use of an Audit Difference Evaluation Form from Practitioners Publishing Company or other publisher of practice aids,  is not to make the numbers come out right.  The purpose is to make sure effective error analysis has been done.  As mentioned above, error analysis should be both quantitative and qualitative.  It may include:

  • Requesting the client make adjustments for some or all of the actual errors.
  • Considering the nature of the projected or estimated errors to isolate causes for further investigation and corrective action.
  • Expanding auditing procedures in the areas that resulted in large amounts of projected or estimated errors.

Most commonly, our error evaluation process will result in some combination of making adjustments for actual errors and "carving out" the causes of our projected or estimated errors.  From an efficiency standpoint, the last thing an auditor wants is to increase sample sizes and perform more sampling procedures.

Good error analysis includes consideration of both the error itself and the condition it may represent.  Qualitative factors may cause small, seemingly isolated errors to have a material effect on the financial statements as a whole.  Here are some qualitative factors that should be considered when evaluating error conditions:

  • Related-party transactions.
  • Errors resulting from conflicts of interest.
  • Errors arising from fraud or illegal acts.
  • Error effects that could be material in some future period.
  • Errors with psychological impacts, e.g., changing earnings from a small profit to a loss or changing cash in bank to an overdraft.
  • Errors symptomatic of larger problems, e.g., numerous sales returns, extensive product warranty claims.
  • Errors affecting contractual obligations such as covenants in debt agreements.

The banner for audit quality truly reads, "Do Good Error Analysis!"  What's in your audit?
 

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.

42614

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.

74897

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.

47599

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.

87446
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.
20023

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".

54723

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.

79446

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.

24587

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.

63140

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

33978
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
101275
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.
25298

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.

51594
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.
27141
Michael Alter's blog specializes in providing practical advice to those who seek greater profitability and practice management tactics that enhance deeper client relationships.
31434

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.

98781

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.

32625

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.

109668

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

59914

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.

38643
Caleb Newquist is the Editor-in-Chief of Sift Media US, overseeing content for both AccountingWEB and Going Concern.
65642

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.

91512

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.

52588