Analytical Review: Meaning, Objectives, and Procedures

An analytical review evaluates financial information by analyzing plausible relationships among both financial and non-financial data. Auditors use these procedures to investigate fluctuations or relationships that are inconsistent with other information or differ significantly from expected values. The approach assumes that, without known contrary conditions, certain data relationships are expected to exist and continue.

These reviews are applied in various stages of a financial statement audit and can range from simple comparisons to complex models involving many relationships. The effectiveness depends on the auditor’s understanding of the company and its industry. By identifying unusual variances, these procedures direct the auditor’s attention to areas with potential misstatements.

Core Objectives of Analytical Reviews

Analytical reviews serve distinct purposes at different phases of an audit: initial planning, substantive testing, and the final review. During the planning stage, analytical procedures are used for risk assessment as required by auditing standards like AS 2110. These reviews enhance the auditor’s understanding of the client’s business and identify areas of specific risk. For example, an unexpected decline in a company’s gross margin could indicate a misstatement in revenue or cost of goods sold, which helps determine the nature, timing, and extent of other audit procedures.

Analytical procedures can also be used as substantive tests to obtain audit evidence about particular assertions related to account balances or transactions. Auditing standards like AS 2305 require the auditor to develop an expectation of an amount and compare it to the company’s reported figure. If the auditor’s expectation is sufficiently precise and the variance is small, this can provide persuasive evidence and potentially reduce the need for more detailed transaction testing.

Finally, analytical reviews are performed during the overall review stage at the end of the audit. This helps the auditor conclude whether the financial statements as a whole are consistent with their understanding of the entity. This final check on the reasonableness of the statements involves reviewing all gathered evidence before the audit report is issued.

Key Data and Information Used

The effectiveness of an analytical review depends on the quality and relevance of the data used. Auditors use a wide array of information to form expectations, and the reliability of this data directly influences the validity of the conclusions.

A primary source of information is the company’s internal financial data, including financial statements from prior periods and company-prepared budgets and forecasts. Auditors compare these against actual results. A significant variance between budgeted and actual revenue, for example, would prompt an inquiry with management to understand the cause.

Auditors also use internal non-financial information to create predictable relationships with financial data. Operational data like employee numbers, production volume, or retail square footage can help develop expectations for related financial accounts. For instance, an auditor can estimate a hotel’s revenue using its occupancy rates, number of rooms, and average room rate to test the reasonableness of the reported figure.

External data provides broader context for evaluating a company’s performance. This includes industry-average financial ratios for benchmarking against competitors and general economic indicators like inflation rates or gross domestic product growth. Comparing a company’s sales growth to its industry’s growth rate helps an auditor assess whether its performance is in line with market trends or if it represents an anomaly that warrants further investigation.

Common Analytical Review Techniques

Auditors use several techniques for analytical reviews, with the choice depending on the account, data availability, and the test’s objective.

Trend analysis involves analyzing changes in an account balance over time. An auditor might review a company’s monthly sales figures for the past three years to identify seasonal patterns or a growth trajectory. A sudden spike in sales in the final month of the fiscal year that deviates from the historical trend would be flagged for investigation to ensure revenue was recognized correctly.

Ratio analysis involves the comparison of relationships between different financial statement accounts or between a company account and non-financial data. Auditors calculate ratios like the current ratio or inventory turnover and compare them to prior periods, budgets, and industry averages. A significant and unexpected decrease in the gross margin percentage could suggest issues with inventory valuation, pricing pressures, or unrecorded costs.

Reasonableness testing is a technique where the auditor develops an independent expectation of an account balance and compares it to the recorded amount. This often involves creating a model using financial and non-financial data. For example, to test payroll expense, an auditor might multiply the number of employees by their average salary rates, factoring in approved pay raises and payroll tax rates, to estimate the total expense for the year. This expectation is then compared to the recorded amount, with any significant difference requiring follow-up.

Documenting Analytical Review Procedures

Auditing standards, like AS 1215, require auditors to document the work performed during an analytical review. This documentation supports the auditor’s conclusions and must contain enough detail for an experienced auditor with no prior connection to the engagement to understand the procedures performed.

The documentation must outline the auditor’s expectation and the factors used in its development. For example, a reasonableness test for interest expense would include the specific calculation, detailing the average debt balance and interest rates used. A statement that an account “seemed reasonable” is insufficient, as the basis for the conclusion must be recorded.

The comparison results between the auditor’s expectation and the company’s recorded amount must be documented. This includes the recorded amount, the expected amount, the calculated difference, and the threshold for what constitutes a significant difference.

If a significant difference is identified, the auditor must document the steps taken to investigate it. This includes summarizing management inquiries, their responses, and any additional audit procedures performed to corroborate the explanations. This record provides a clear trail of how the issue was resolved.