Learning Objective 4: Perform Preliminary Analytical Procedure

Learning objective 4
Perform Preliminary Analytical Procedure:
 Preliminary Analytical Procedure:
 Comparison of client ratios to industry or competitor benchmarks

provides an indication of the company’s performance.
 Preliminary tests can reveal changes in ratios.

Analytical Procedures
Analytical procedures may be performed at any of three times during an

engagement:
1- Analytical procedures are required in the planning phase to assist in

determining the nature, extent, and timing of audit procedure.
 Analytical procedures done in the planning phase typically use data

aggregated at a high level, and the sophistication, extent, and timing of
the procedure vary among clients.
2- Often done during the testing phase:

 Analytical procedures are done during the testing phase of the audit as a
substantive test in support of account balances.
 These tests are often done in conjunction with other audit procedures, for
example: the prepaid portion of each insurance policy might be
compared with the same policy for the previous year as a part of doing
tests of prepaid insurance.
 The assurance provided by analytical procedures depends on the
predictability of the relationship, as well as the precision of the
expectation and the reliability of the data used to develop the expectation
3-Required during the completion phase:

 Analytical procedure are also required during the completion phase
of the audit.
 Such tests serve as a final review for material misstatements or
financial problems and help the auditor take a final “objective look”
at the audited financial statement.
 Typically, a senior partner with extensive knowledge of the client’s
business conducts the analytical procedures during the final review
of the audit files and financial statements to identify possible
oversights in an audit
Five Types of analytical procedures
Compare Client data with:

1. Industry Data.
2. Similar Prior-Period data.
3. Client-determined expected results.
4. Auditor-determined expected results.
5. Expected results using non-financial data.
1-Compare Client and industry data
 Using industry data may provide useful information about the client’s
performance and potential misstatement.
 The most important benefits of industry comparisons are to aid in

understanding the client’s business and as an indication of the likelihood
of financial failure they are less likely to help auditors identify potential
misstatement.
 Major weakness in using industry ratios for auditing is the difference

between the nature of the client’s financial information and that of the
firms making up the industry totals. Because the industry data are broad
averages, the comparisons may be meaningful.
2-Compare Client and industry data with similar
prior-period data
A-Compare the current year’s with that of the preceding year one of the
easiest:
 Ways to perform this test is to indicate the preceding year’s adjusted trial
balance results in a separate column of the current year’s trial balance
spreadsheet.
 The auditor can easily compare the current year’s balance and previous
year’s balance to decide. Early in the audit, whether an account should
receive more than the normal amount of attention because of a significant
change in the balance.
 A wide variety of analytical procedures allow auditors to compare client data

with similar data from one or more prior periods.
prior-period data
B- compare the detail of a total balance with similar detail
for the preceding year:
 comparing the detail of the current period with similar detail of the
preceding period. Auditors often isolate information that needs further
examination.
 Comparison of details may take the form of details over time, such as
comparing the monthly totals for the current year and preceding year
for sales, repair, and other accounts or details at a point in time.
 In each point of these examples, the auditor should first develop an

expectation of a change or lack thereof before making the comparison.
prior-period data
c- Compare ratios and percent relationships for comparison with
previous years.
 comparing totals or details with previous years has two shortcomings.
• First, it fails to consider details growth or decline in business activity.
• Second, relation ships of data to other data, such as soles to cost of
goods sold, are ignored.
 Ratios and percent relationships overcome both shortcomings, for

example: the gross margin is a common percent relationship used by
auditors.
3-Compare Client data with client determined
expected results
 Budget represent the client’s expectations for the period, auditors
should investigate the most significant differences between
budgeted and actual results, as these areas may contain potential
misstatement.
 When client data are compared with budgets, there are two
special concerns:
• First: the auditor must evaluate whether the budgets were realistic plans.
• Second: the probability that current financial information was changed by
the client personnel to confirm to the budget.
 Assessing control risk and detailed audit tests of actual data are
usually done to minimize this concern.
4-Compare Client data with auditor determined
expected results
 The auditor makes an estimate of what an account balance
should be by relating it to some other balance sheet or income
statement account or accounts or by making a projection based
on non-financial data or some historical trend.
 For Example, the auditor may make an independent calculation

of interest expense on notes payable by multiplying the average
ending balances and interest rates for both short-term and long-
term notes payable as a substantive test of the reasonableness of
recorded interest payable.
5-Compare Client Data with Expected Results Using Non-
financial Data
 The major concern in using nonfinancial data, however, is

the accuracy of the data. You may develop an expectation
for total revenue from rooms by multiplying the number of
rooms, the average daily rate for each room, and the
average occupancy rate.
 Auditor can then compare your estimate with recorded

revenue as a test of the reasonableness of recorded revenue.
Common Financial Ratios
 Short-Term debt paying ability.
 Liquidity nativity ratios.
 Ability to meet long-term debt obligations.
 Profitability ratios.
Summary of Analytical Procedures
 Compare ratios of recorded amounts to auditor expectations.
 Used in planning to understand client’s business and industry.
 Used throughout the audit:

• to identify possible misstatement.
• Reduce detailed tests.
• Assess going-concern issues.

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Learning objective 4

Perform Preliminary Analytical Procedure:

 Preliminary Analytical Procedure:

 Comparison of client ratios to industry or competitor benchmarks

 Preliminary tests can reveal changes in ratios.

Analytical procedures may be performed at any of three times during an

1- Analytical procedures are required in the planning phase to assist in

 Analytical procedures done in the planning phase typically use data

2- Often done during the testing phase:

3-Required during the completion phase:

Compare Client data with:

 The most important benefits of industry comparisons are to aid in

 Major weakness in using industry ratios for auditing is the difference

 A wide variety of analytical procedures allow auditors to compare client data

 In each point of these examples, the auditor should first develop an

 Ratios and percent relationships overcome both shortcomings, for

 For Example, the auditor may make an independent calculation

 The major concern in using nonfinancial data, however, is

 Auditor can then compare your estimate with recorded

 Short-Term debt paying ability.

 Liquidity nativity ratios.

 Ability to meet long-term debt obligations.

 Compare ratios of recorded amounts to auditor expectations.

 Used in planning to understand client’s business and industry.

 Used throughout the audit:

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