What are Substantive Analytical Procedures?

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Critically relevant to F8 and P7 Candidates

Tutorial Notes:

Explanation of analytical procedures

'Analytical procedures' means evaluation of the financial and other information, and the review of plausible relationships among both financial and non-financial data. For example, sales have a direct relationship with royalty expenses, provided royalty payments are based on the number of units sold. Therefore analytical procedures will include determining whether the sale for a period has a direct relationship with the royalty expenses incurred during the same period.

The analytical procedure also includes investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts. For example if the relationship between sales and royalty expenses is not direct, then the auditor would investigate the reasons for the deviations because it indicates a possibility of a misstatement of either sales or royalty expenses in the financial statements.

Analytical procedures help in understanding an entity and its environment and its overall review at the end of the audit. They are also used as substantive procedures when their use can be more effective or efficient than tests of details, in reducing the risk of material misstatement at the assertion level to an acceptably low level.

How can Substantive Analytical Procedures by used?

The different types of analytical procedures available to the auditor are as follows:

Comparison with prior periods

Comparable information of the current year is compared with information relating to prior periods. This comparison helps to identify unusual changes or fluctuations in amounts. For example a comparison of revenue and gross profits of the current year with the amounts of the previous year will help determine the percentage of growth in sales and whether the gross profit margin was similar as in the previous year.

Another Example: 

The contagious virus H7N9 is spreading in China. What is the plausible relationship to the air travel industry? The expectation is FEWER travellers to China and rest of Asia. Thus, expect that the highly geared airline companies with high exposure to Asian markets to have significant lower passengers load and may pose a Going Concern risks. 

Pic 01: Bird Flu making Chinese nervous? Or Doctors on way to work?

Pic 02: Chip! Chip! Chip! Buy 1 Free 2.

Pic 03: Expect airline industry in Asia to experience big declines. A Going Concern issue?

Pic 04: Travelers thinking, "Where to go? Beijing? Sao Paolo? "

Comparison with anticipated resulted

Actual results are compared with anticipated results of the entity or budgets and/or forecasts. Unusual discrepancies identified by the comparisons indicate a possibility of misstatement in the area where the discrepancy is noticed. This would have to be investigated by further audit procedures. For example a comparison of sales will be made with budgeted sales and if major deviations are noticed, these would have to be investigated. In fact if the actual results show a significant fall as compared to the budgeted results, the auditor may have to investigate whether the going concern status of the entity is affected.

Comparison with industry information

Client information is compared with industry information either for the industry as a whole or by comparison with entities similar in size to the client. For example, receivable days of a client are compared with the receivable days of the industry.

End of Tutorial Notes

Next article, I will demonstrate how you apply them on Government Top Think Tank's PEMANDU's performance.