Identify four limitations of using analytical procedures at the planning stage of an audit

Advantages of Analytical procedures
(1) The principal advantage of analytical procedures is that they can be applied at all stages of the audit to inquire into the absolute amounts to be reflected in the financial statements, and into the relationships between those amounts.
(2) These procedures are a good test for the overall reasonableness of an amount. They can be applied on a universal basis, and they can be broken down into their individual elements.
(3) Analytical procedures helpthe auditor to make comparisons on a regular basis, taking prior years into consideration, and providing the auditor with a better understanding of both the business as a whole, and of individual account areas.

Disadvantages of Analytical procedures

(1) Since analytical procedures often have to be performed on draft or incomplete accounts before the final financial statements have been prepared, significant adjustments, which are often made at a later stage, are not taken into consideration.
(2) Without a proper understanding of the business, the auditor may be tempted to accept the results of analytical procedures that show no unusual variations, which may not be the case if there have been significant changes in the business of which the auditor is unaware and which management may try to conceal from the auditors.
(3) Auditors may also be tempted to accept ‘plausible’explanations for changes and variations without much further substantiation, where further investigation mayactually be needed.

2 Substantive analytical procedures

When the auditor decides to apply substantive procedures then it can apply either of the two OR combination of both types of substantive procedures:

• Test of details
• Substantive analytical procedures

The decision about which type to use depends on auditor’s judgement whether available audit procedures will reduce the audit risk to an acceptably low level efficiently or effectively.

Substantive analytical procedures require information on which they can be applied. Auditor has the following options in this regard:

1. Obtain required information himself and apply the substantive analytical procedures.
2. Use the information provided by the management and apply his own substantive analytical procedures
3. Rely on the results of analytical procedures already conducted by the management

In case of b and c above, auditor has to satisfy himself about the reliability of information and results and how such information and results are prepared. This can be done, for example, by inquiring management.

2.1 Important factors to consider

In order to use analytical procedures as substantive procedures, auditor is required to:

1. Ensure whether particular substantive analytical procedure is appropriate for a given assertion by considering the results of risk assessment and test of details.
2. Assess the reliability of information on the basis of which auditor expects to draw conclusions.
3. Develop an expectation (i.e. what the entity’s financial statements’ figures should be or what ratio analysis should confirm) using the information evaluated in the step above. Once expectation is derived assess whether expectation is appropriate to a level that it can help in identifying misstatements in entity’s recorded amounts and ratios that may be material in nature.
4. Establish materiality level i.e. the difference or fluctuation or inconsistency in actual facts and figures against expectations can be accepted without further inspection.

2.1.1 Appropriateness of analytical procedures

Where analytical procedures are easier to apply, at the same time we must recognize that analytical procedures may not be suitable due to the following reasons:

the limitations of analytical procedures because of the following assumptions:

• These are mostly applicable to such transactions that occur on repetitive and are expected to follow a certain pattern that can be expected.
• The expected relationship continue to exist unless differing condition arises

Therefore, it is left on auditor’s judgement to decide whether selected analytical procedures can efficiently and effectively detect a misstatement.

Analytical procedures need not to be very complex to be effective. Even a simple comparison of financial and non financial data or ratios can provide sufficient appropriate audit evidence. For example: comparing payroll costs with number of employees working.

Different analytical procedures provide varying levels of assurance.

The suitability of analytical procedure is also affected by:

• Nature of assertion
• Assessed risk of material misstatement

Some analytical procedures may be suitable when applied in combination with test of details on the same assertion.

2.1.2 Reliability of information

Reliability of information is assessed by considering:

• Source of information. Auditor may place more reliance on information obtained directly by him then the information provided by the management or through management.
• Comparability of information. Entity should be compared with such other entity which is from same industry and is of same size working under similar circumstances.
• nature, relevance and the
• controls that were exercised in preparing such information

To be satisfied, auditor may test the controls applied while preparing information as effective controls raise auditor’s confidence in information and the results derived from analytical procedures applied on such information.

2.1.3 Evaluating expectation

In order to assess whether the expectations developed are sufficiently précised, the following questions require answer:

• The predictability of expected results and the accuracy of such predictions. Sales revenue and related gross margin on newly launched product will be lesser predictable then the relatively old products.
• The extent to which information can be broken down. If entity is selling more than one product then analytical procedures applied regarding each product’s profitability will provide evidence then the analytical procedures applied taking total figures of all products.
• The availability of information with its financial and nonfinancial constituents. Revenue generated with the number of units sold helps the auditor in gaining better insight about entity’s sales trend over a period of time.

2.1.4 Determining materiality

Materiality determines the amount of difference from expected results can be accepted without further examination of the matter. However, auditor considers whether such difference or misstatement individually or when combined with other misstatement can amount to material misstatement or not. The determination of materiality level depends on auditor’s assessment of risk of material misstatement. If the risk increases then auditor will lower the materiality level i.e. amount of difference that can be tolerated will be decreased. This will increase the investigation work to be done by the auditor.

What are analytical procedures in planning an audit?

What are the 5 types of analytical procedures?

What are the limitations of audit?

At what stages of the audit are analytical procedures performed?