ANALYTICAL REVIEW-ISA 520 - Financial Auditing - Business Writing Services

Analytical review can be defined as the study of relationships between element of financial
information expected to conform to a predictable pattern based on the organizations experience
and between financial information and non-financial information.

Under analytical review information is compared with comparable information for prior records
with anticipated results and with information relating to similar organizations.

In an actual case, analytical review can be applied by examining: -

1. Increases in magnitude corresponding to inflation
2. Changes in amounts consequent on changes in output levels
3. Comparison with previous periods
4. Trends and ratios
5. Comparisons with budgets and forecasts
6. Comparisons with other similar organizations e.g. inter-firm comparison

The Timing of Analytical Review Techniques

This will be applied throughout the audit but the specific occasions will include:

1. At the planning stage: at this stage the auditors will hope to identify areas of potential
risk or new developments so that he can plan his other audit procedures in these areas.

2. During the audit as a substantive procedure for obtaining audit evidence: modern
audits with their emphasis on efficiency and economy depend heavily on analytical review as a
valid audit technique used alone on in conjunction with the internal control reliance and
substantive testing. It can be reasonable to obtain assurance of the completeness, accuracy
and validity of transactions and balances by analytical review as by other types of audit
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ANALYTICAL REVIEW-ISA 520 - Financial Auditing - Business Writing Services
evidence. E.g. if the relative amounts under different expense headings repeat the pattern of
previous years, the auditor will have evidence of the accuracy of expense invoice coding.

3. At the final review stage of the audit: analytical review techniques can provide support
for the conclusions arrived at as a result of other work. E.g. indications from external sources
that profit margins have declined by 10% may support the declined profit figure in a segment of
the company whose figures have audited by other means and found to be correct. The
techniques are also used to assess the overall reasonableness of the financial statements taken
as a whole.

Extent of use analytical review procedures

The factors which might affect the extent of use of analytical review include:

1. The nature of the entity and its operations: e.g. a long established chain of similar
shops which changed little in the period under review will offer many opportunities for analytical
review to be used as a primary source of audit evidence. Conversely a newly established
manufacturer of high-tech products will not provide such an opportunity.

2. Knowledge gained from previous audits of the enterprise: the auditors will have
experience of those areas where errors and difficulties arose and those areas of greatest audit
risk.
3. Managements own use of analytical review procedures: if management has a reliable
system of budgetary control then the auditors will have already made source of explanation for
variances. If management uses information that has been subjected to internal audit review, the
reliability of that information is enhanced. If the staff who produce the information are competent
and have integrity again the reliability of information is enhanced.

4.
Availability of non-financial information to back up financial information

5. The cost effectiveness of the use of analytical review in relation to other forms of
evidence : in general analytical review is cheap but requires high quality staff. Some
techniques can be expensive if they involve statistical techniques.
6. Availability of staff: analytical review requires high quality staff with much intelligence,
experience and training.

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ANALYTICAL REVIEW-ISA 520 - Financial Auditing - Business Writing Services
The auditors procedures:

1. Identify the factors likely to have an effect on items in the accounts
2. Ascertain or assess the probable relationship between these factors and the items.
3. Predict the value of the item in the light of the factors.
4. Compare the predicted value with the actual recorded amount.
5. Consider the implications of significant fluctuations, unusual items, or relationships that
are unexpected or inconsistent with evidence from other sources. Similarly consider the
implications or predicted fluctuations that fail to occur.
6. Discuss with management any significant variations therefore management will usually
have an explanation for the variation. Seek independent evidence to support management
explanations.
7. React to significant fluctuations or unexpected values. The auditors reaction depends on
the stage of the audit at which he is carrying out analytical review. If at the planning stage- plan
suitable detailed substantive tests. If during the audit-then further audit tests will be indicated.
All fluctuations and unexpected values must be fully indicted and sufficient audit evidence
obtained.
8. As with all audit work analytical review procedures should be fully documented in the
working papers. Files should include:-

1. The information examined with detailed calculations and explanations ofinfluences
expected.
2. The management explanation of significant fluctuation
3. The verification of these explanations
4. The conclusions drawn by the auditor
5. Details of further tests if any

Please note the following:

- Any relationship perceived between variables must be plausible ie the relationship found
should be reasonable and relevant to audit objectives. E.g. debtors and sales have a plausible
relationship but theres no plausible relationship between selling expenses and work in progress
(W.I.P.) in a manufacturing account.
- Also note that the nature of analytical review includes the comparison over time and the
use of past experience on the audit therefore it is desirable for the auditor to build up a picture
of the organisation and the relationship between magnitudes in the permanent audit files.
- Materiality is very important thus those areas not judged to be material, the auditor will
very often rely wholly on analytical review to conclude. But material areas require a combination
of compliance testing, analytical review and detailed substantive testing.

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ANALYTICAL REVIEW-ISA 520 - Financial Auditing - Business Writing Services
Analytical review in practice:

1. The auditor will always establish a trend analysis most common trend analysis being a
5-year side-by-side balance sheet and detailed profit and loss account.
2. A trend analysis of key profit and loss figures within the year under review such as a
monthly summary of the sales and related expenses.
3. Ratio analysis: for the profit and loss account growth in percentage terms of key figures
will be worked out.

The figures will also be compared with the budget with variations being expressed maybe in
percentage terms. The previous years figures may also be put alongside. Gross profit margin is
also a figure that is worked out along the same lines. Gross profit margin will be compared to
that of the previous year and that of the budget usually the Gross profit margin is expected to be
steady. If it has fluctuated significantly then the components that make up the Gross profit figure
particularly sales, purchases and closing stocks are further investigated.

The proportion to sales of those items that have a plausible relationship with sales is worked
out. These could include selling and distribution expenses such as advertising and motor
vehicle running expenses.

If industry averages are available the organisations figures are also compared to those
averages.

Balance sheet ratios that are usually considered:-

- Fixed Assets (FA):

(i) The utilisation of FAs is usually worked out. This is: Turnover

FA (NBV)
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ANALYTICAL REVIEW-ISA 520 - Financial Auditing - Business Writing Services

To determine how much sales are generated for every shilling invested in FAs. It is normally
called the FA turnover ratio.

(ii) Global depreciation ratio is also worked out which involves taking the NBV of the FAs
divided by the depreciation charge in the profit and loss account. The resultant figure gives a
rough estimate of the average remaining useful life of the assets. Too big a figure indicating that
maybe the rates of depreciation used are too low.

- Stocks:

The percentage increase is calculated and is compared with the corresponding percentage
increases in purchases. If the two increases do not correspond, it may indicate that the
provision for obsolescence is inadequate.

The stock turnover ratio is also worked out. To ensure that were comparing like with like, the
cost of sales figure is used and not the sales figure. A slowing down turnover ratio may also
indicate that the provision for obsolescence is also inadequate therefore it would appear that the
demand for the products of the organisation may be diminishing.

- Debtors:

The percentage increase in debtors is worked out and this is compared with the percentage
increase in turnover. It is usually being expected that an increase in turnover ordinarily should
have a corresponding increase in debtors. Debtors to sales ratio is also worked out to determine
the number of days sales in debtors. This number of days is compared with the normal allowed
credit period. It measures the effectiveness of credit control and consequently the adequacy
provision for bad and doubtful debts.

- Liquidity ratios are then worked out, the most common of which are:
-
- The current ratio
- The acid test ratioFor cash at bank an additional measure is consideration of the overdraft
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ANALYTICAL REVIEW-ISA 520 - Financial Auditing - Business Writing Services
limit for trade creditors. The percentage increase is worked out and compared with the increase
in the cost of sales. Also the number of days purchases in creditors worked out to measure the
difference between credit taken and credit allowed by suppliers.


- The gearing ratio is worked out to measure the companys exposure or the cost of external
capital to the organisation.

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