Analytical Procedures

Analytical procedures are techniques used in financial auditing and analysis to evaluate financial information through comparison and analysis. These procedures involve using ratios, trends, and comparisons of financial information. One of its primary aims is to identify potential risks and areas of concern.

It also aims to assess the overall financial statement, evaluate internal controls' effectiveness, increase the audit process's efficiency, and provide valuable information for decision-making. It can be performed at various stages of the audit or analysis process, including planning, substantive testing, and overall review. They can be performed manually or with the help of computer software.

• Analytical procedures in an audit are a powerful tool that can help auditors gain insights into the financial performance of an organization. It can be used at different stages of an audit, including planning, interim review, and final review.
• Risk assessments are performed at the planning stage of the audit to identify areas of the financial statements that may be at higher risk of material misstatement or errors.
• Substantive analytical procedures are performed to test account balances or transactions and to obtain audit evidence supporting financial statement assertions.

Analytical procedures can be highly effective in financial auditing and analysis. These challenges include data availability and quality, subjectivity, limitations of the techniques, industry-specific challenges, and interpretation of results.

Let us understand it in light of its usage and challenges ahead.

Importance

Some of them are below.

1. Enhanced Efficiency: It helps auditors and analysts quickly identify potential financial statement issues. By identifying potential risks early in the audit or analysis process, auditors and analysts can plan their work more effectively, improving overall efficiency.
2. Improved Quality of Financial Reporting: It can help identify errors, omissions, or other irregularities in financial statements. By identifying these issues, auditors and analysts can help to ensure that the financial statements are accurate and complete.
3. Enhanced Risk Assessment: It helps auditors and analysts to assess the risk of material misstatements in the financial statements. By identifying potential risk areas, auditors and analysts can develop appropriate audit or analysis procedures to mitigate those risks.
4. Better Decision Making: It provides valuable information to management, investors, and other stakeholders.

Challenges

The challenges of it can be understood in the following ways.

1. Data Availability and Quality: It requires reliable and accurate financial data. If the data is available and of good quality, the results of the analytical methods may be reliable.
2. Subjectivity: It requires judgment and interpretation, which can introduce subjectivity. The results of analytical methods may result from the auditor or analyst's personal biases or assumptions.
3. Limitations of the Techniques: It has restrictions, such as the inability to detect fraud or errors that are difficult to detect.
4. Industry-Specific Challenges: It may be more difficult in specific industries, such as the technology industry, where the underlying data may be more complex or difficult to interpret.
5. Interpretation of Results: The results of it can be challenging, mainly if they are unusual. Auditors and analysts must be able to analyze the results of the analytical methods and determine whether further investigation is necessary.

Some of the common types of analytical methods include:

1. Trend Analysis: Trend analysis involves comparing financial data from one period to another to identify trends or changes over time. This can help auditors and analysts to identify areas of concern or to assess the reasonableness of financial statement balances.
2. Ratio Analysis: Ratio analysis involves the comparison of financial ratios to industry benchmarks, prior year results, or other relevant factors. This can help auditors and analysts evaluate an organization's financial health and identify potential risk areas.
3. Regression Analysis: Regression analysis involves using statistical techniques to identify relationships between different financial variables. This can help auditors and analysts to identify potential areas of concern or to develop predictive models.
4. Variance Analysis: Variance analysis involves comparing actual financial results to budgeted or expected results to identify areas of variance. This can help auditors and analysts identify areas of concern or assess internal controls' effectiveness.
5. Reasonableness Analysis: Reasonableness analysis involves comparing financial information to external data sources, such as industry averages or publicly available financial information. This can help auditors and analysts to evaluate the reasonableness of financial statement balances and to identify potential areas of risk.

Preliminary analytical procedures involve several steps, including planning, conducting the operations, and evaluating the results. The following are some general steps for performing analytical methods:

1. Planning: Identify the objective of it, the areas of focus, the financial data required, and the data sources. Consider the availability and reliability of the data, as well as any potential limitations of it.
2. Conducting the Procedures: Collect and analyze the financial data using the selected procedures. This may involve calculating ratios, performing trend analysis, conducting variance analysis, or using other techniques as appropriate.
3. Evaluating the Results: Evaluate the results of the procedures to determine whether they are consistent with expectations. If the results are unusual, investigate further to determine the cause. Consider the impact of issues on the financial statements and whether further testing or evaluation is necessary.
4. Documenting the Procedures: Document the procedure performed, including the data sources, the techniques used, and the results. In addition, note any issues identified and the actions are taken to resolve them.
5. Communicating the Results: Communicate the results of the procedures to management, auditors, or other stakeholders, as appropriate. Provide any insights or recommendations based on the results of the analytical methods.

Let us understand it in the following ways.

Example #1

Let's say that ABC Corp is preparing its financial statements. This is for the year ending December 31, 2022. The auditor wants to use trend analysis to identify any significant changes in revenue over the past three years. The auditor obtains the following revenue figures for the company:

• Year ended December 31, 2022: $10,000,000
• Year ended December 31, 2021: $9,000,000
• Year ended December 31, 2020: $8,000,000

To perform the trend analysis, the auditor would first calculate the percentage change in revenue between each year, as follows:

• Percentage change from 2021 to 2022: ((10,000,000 - 9,000,000) / 9,000,000) x 100 = 11.1%
• Percentage change from 2020 to 2021: ((9,000,000 - 8,000,000) / 8,000,000) x 100 = 12.5%

Next, the auditor would compare the percentage changes to determine if there are any significant trends or changes over the past three years. In this case, the trend analysis shows that there has been a consistent increase in revenue over the past three years, with a significant increase of 11.1% from 2021 to 2022. So, again, this may be a positive indicator of the company's financial health and performance.

The auditor could then investigate further to determine the reasons for the increase in revenue, such as changes in market conditions or business operations. This could help identify potential areas of risk or concern and inform the overall audit approach.

Example #2

Amazon, the world's largest online retailer, uses validation of analytical procedures to assess customer behavior and preferences and to make data-driven decisions to improve its operations and profitability.

One example is Amazon's use of customer analytics to identify which products are most popular with different customer segments and tailor its product recommendations and marketing efforts accordingly. By analyzing customer purchases, search queries, and other behaviors, Amazon can identify patterns and trends in customer behavior and adjust its product offerings and marketing messages to better meet customer needs and preferences.

This has been a guide to what are Analytical Procedures. Here we explain them in detail with their examples, types, and ways to perform them. You can learn more about accounting from the following articles –

• Fault Tree Analysis
• Quantitative Risk Analysis
• Factor Analysis