Auditing Special Purpose Frameworks: Analytical Procedures

Larry Perry
CPA Firm Support Services, LLC
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Audits of all types of reporting frameworks will benefit from the effective use of analytical procedures in planned audit strategies. When more substantive evidence is obtained from risk assessment and analytical procedures, less evidence is required from more costly tests of balances procedures. Analytical procedures may consist of absolute comparisons of dollar balances with prior years' account balances, or with budgets, ratio comparisons and trend analysis. They may also consist of computations based on financial or operational data designed to predict the balance in a financial statement classification.

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 responses to inquiries of reporting entity personnel; and searching for the cause of a problem beyond its symptoms are all examples of analytical thinking. The term "professional skepticism" is used in the Clarified Auditing Standards to describe this kind of thinking. It is loosely defined as neither blindly trusting every client nor, on the other hand, considering each client dishonest as information is gathered.

When the results of analytical procedures contribute evidence to evaluate 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 evidence for evaluating the financial statement assertions. Computations designed to predict the balance in a financial statement classification that are based on audited financial or operational data (e.g., quantity reconciliations and reasonableness tests) are the most effective analytical procedures. Corroborating procedures performed at lower levels of detail are more effective than corroborating procedures based on balances of financial statement classifications.

Examples of analytical procedures, in the order of their effectiveness, are:

  1. Quantity reconciliations

Multiplying the number of units sold times sales price to predict sales revenue, or multiplying the number of employees times weekly or monthly salaries to predict salaries and wages expense, for example, can contribute a majority of the evidence necessary to enable an auditor to evaluate the relevant financial statement assertions for these income and expense accounts. Some normal tests of balances for related balance sheet accounts, such as accounts receivable for sales and accrued salaries and wages for payroll accounts, at the beginning and end of the reporting period, would still be necessary, however.

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, beginning and ending numbers from the meter would need to be physically obtained to establish the reliability of the log. To determine the meter had not been altered, it may also be necessary 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.

  1. Reasonableness tests

Computations performed by estimating depreciation for asset classifications based on average lives and methods, and using one-half year depreciation for additions and disposals, are examples of reasonableness tests. 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 not as effective as quantity reconciliations in providing evidence to evaluate financial statement assertions. Since they are usually applied to smaller account balances, however, other tests of balances may not be necessary.

  1. Corroborating procedures

The most common analytical procedures, such as absolute dollar comparisons of account balances and ratio analysis, provide evidence that corroborates other risk assessment procedures and tests of balances. While using corroborating analytical procedures may enable some modification of the nature, extent, and timing of tests of balances procedures, more extensive tests of balances procedures will ordinarily be necessary to gather sufficient evidence for satisfactory evaluation of relevant 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.

AU-C 520, Analytical Procedures, instructs auditors to use analytical procedures during the planning and review phases of an engagement, as well as for generating substantive evidence for certain financial statement classifications. AU-C 315, Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement, clarifies the use of analytical procedures as risk assessment procedures.

An illustrative Analytical Procedures Program that presents some of the common types of analytical procedures that may be applied to material financial statement classifications, and that demonstrates their use in audit planning, is available by registering through the "News" box on my website,, and making a request using the "Contact Us" tab.


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