Analytical Procedures in Auditing

Analytical Procedures as Substantive Evidence

• Analytical procedures in planning/review stages cannot be used as substantive evidence
• If properly designed, analytical procedures can test assertions for income statement items
• Develop expectations for account balances using plausible relationships
• Material differences between actual and estimated balances must be investigated

Quality of Analytical Procedures Evidence

• Evidence quality depends on data reliability and estimate precision
• Data reliability improves with strong internal controls
• Precise estimates depend on detailed data disaggregation and considering variations in components

Materiality at Account Level

• Representative sample errors at account level are extrapolated to the population to determine likely misstatements.
• Example: If $20,000 errors are found in a $250,000 sample of a $1 million account, the likely misstatement is $80,000.
• Aggregate all account-level errors and compare to account-level materiality.
• Account sampling is used to represent a population, but could lead to over or underrepresentation.

Materiality at Financial Statement Level

• Account level errors are aggregated to the financial statement level
• This is used to determine the impact on key items like net income and net assets
• Compare the aggregate errors to financial statement materiality
• Materiality is calculated based on the effect on a financial statement user's decision.

Materiality Evaluation

• If aggregate misstatements exceed materiality:
  • Management should recheck high-risk areas and correct any errors
  • Perform more audit procedures
  • Management should correct any remaining misstatements
• If misstatements remain material, the audit report needs qualification

Types of Misstatements

• Factual/Known: Obvious misstatements
• Judgmental: Misstatements resulting from unreasonable management estimates or inappropriate GAAP application
• Projected: Misstatements projected from a sample to a larger population

Communication of Misstatements

• Uncorrected misstatements should be communicated to management and their audit committee
• Small misstatements may not need to be communicated to the board
• Larger misstatements should be communicated to the board

Revisions to Materiality

• Materiality is not always revised but should be reviewed if new information arises to cause a different initial determination.
• If revisions are made, consider the implications for planned procedures

Case Writing Tips: Materiality

• Determine performance materiality (e.g., 75% of materiality) as a buffer for uncorrected/undetected misstatements
• Add back non-recurring transactions to normalize income

Levels of Assurance

• High assurance (Audit): Positive assurance ("In our opinion...")
• Middle assurance (Review): Negative assurance ("Nothing has come to our attention")
• No assurance (Compilation): No attempt to verify accuracy or completeness

Unqualified Independent Auditor's Report

• The most common audit report type
• Many companies require an unqualified opinion

Key Audit Matters (KAMs)

• Relevant to listed entities, required in some cases
• Key matters communicated with the audit committee
• Maters that require significant auditor attention
• Identify areas of high risk

Departures from GAAP

• Financial statements need to follow GAAP. Departures may result in a Qualified, Adverse, or Disclaimer of opinion
• Materiality: If material but not pervasive, a qualified opinion results
• If material and pervasive, an adverse opinion is expressed

Scope Limitations

• Scope limitations involve an inability to obtain sufficient evidence which can lead to a qualified opinion or disclaimer of opinion
• Conditions beyond the client's control or management imposed limitations can cause scope limitations.

Reliance on Another Auditor or Specialist

• Group auditors are responsible for the group audit opinion.
• Auditors must evaluate the work of specialists to ensure it is reasonable.

This quiz covers analytical procedures used as substantive evidence in auditing, discussing how they can test income statement assertions and the factors that affect the quality of evidence. It also addresses materiality at the account level and methods to estimate likely misstatements based on sample errors.