Audit Evidence: Analytical Procedures - Lesson 1 - YouTube

Okay, let's talk about analytical procedures.

Now, with analytical procedures, remember over here we said, audit procedures. Two types,

testive details of accounts transactions, balances and disclosures and analytic procedures,

that's what we're looking at now. Now what are analytical procedures? That's

part of your ICORRIIA. Analytical procedures are the study of data comparisons and relationships.

How information's compare or relate relationships. This is based on the anticipation or expectation

theory. This deals with ratios, ratio analysis. So what we're looking at is how does the number

compare? How does it relate based on the expectation? What did you get versus what did you expect

to get? That tells us that you know what? This account may have changed by more or less

than we expected. So we're going to do this at the beginning of the audit. We're going

to do this at the end of the audit. Because at the beginning, we're going to look at all

the clients transactions. So for example, here's let's say X1, here's

X2, dollar change, percentage change and we're going to set up maybe parameters. We're going

to say, we're looking at all the changes greater than 10,000 dollars and five percent.

Now notice, this is because you may have a change in this account by one million dollars

but it's only one percent. Well that's reasonable. You may have another that's a 42 percent change

but it's only 27 dollars, who cares? Immaterial. What you're looking for is a 17,000 dollar

change. That's maybe nine percent. You know what? That exceeds both 10,000 and five percent.

That's something that maybe we didn't expect. So when planning the audit you sit down and

you go, you know what? In looking at the changes, this is current year, prior year, PY. So here's

current year, here's PY which means prior year. You know what? This change is bigger

than we expected, then we anticipated. So what we need to do is go back and go, you

know? It changed by more than we thought. Is that reasonable? Or could there be a mistake?

At the end of the audit you do the same thing. Because as I mentioned earlier, this is called

test of details. This is when you're looking at the detail and you're looking but the problem

is you get lost when you can't see the forest for the trees. Because you're in the detail

of the trees. Step back and see the whole forest and go, in the details of the trees,

this one transaction, let me ask questions, let me confirm, let me observe, let me recalculate,

let me reperform it, let me look at the document, look at the assets, let me do that on this

one transaction but when you step back and the whole account balance you go, does this

make sense? Does this change seem reasonable? That's comparing. That is relationships. So

the comparison, relationships, anticipation, expectation, ratio analysis. That's an important

concept, ratio analysis. Now, in looking at the ratio analysis, there's

a couple of different comparisons you can do. Now another mnemonic or memory aid is

CRAFT, meaning client versus industry. So one of the things we do is what is the client

versus the industry standard? So for example, maybe we're looking at client

sales and we're looking at how it compares to revenues of competitors. Related accounts

so for example, how does the change in interest expense affected by changes in notes payable,

loans payable, bonds payable? I mean you expect a correlation right? If I've got a home mortgage

at five percent then you expect your interest expense to be, you know, based on that.

So if interest expense goes up and down but this hasn't changed, there's a problem there.

Actual versus budget again, actual what did you expect versus what did you get. Maybe

things that don't change, maybe payroll expense. Payroll expense, unless you hire or fire a

lot of people, should be pretty consistent. If everybody got a three percent raise then

payroll expense should go up by about three percent. If it goes up by 13 percent, you

go, wait a sec, maybe there's a mistake there. Financial versus nonfinancial. Airlines might

say number of passengers versus total airline revenues. So they're saying, okay let's look

at the passengers, the revenues, and kind of compare that. Current year versus prior

year. This year, prior year. So let's look at, for example, income statement amounts

this year versus prior year. Now, a questions that's come up. What is better

for analytical procedures, balance sheet or income statement? Hmm, balance sheet or income

statement, let's think about it. The balance sheet is what? Cumulative, right? Beginning

cash plus change in cash equals ending cash but it's cumulative, the ending includes the

beginning. Whereas an income statement is this year only, this year only.

So, income statements are better for analytical procedures because balance sheets change day

to day to day, where the income statement you expect there to be some consistency throughout

the year. If I look at total sales this year versus costs of goods sold, the percentage

should be similar next year and next year and next year. Sales should stay pretty consistent

or maybe go up every year but we're going to look at that whereas cash, a balance sheet

account. Let's say December 31st I get a huge amount

of prepayment, cash goes way up. Maybe I've made a prepayment, cash goes way down. So

you can play with those balance sheet numbers pretty easily whereas your income is accrual

basis right? It's an accrual world, we're using accrual accounting which we'll learn

in financial and in regulation as well for tax purposes, cash versus accrual but basically

accrual basically says we're looking at the money earned whether you received it or not.

Whereas cash is what you receive, what you've paid. So that's why one of the questions,

what do you think is better for ratios? Is it balance sheet or income statement? Generally,

income statement.