Definition: Analytical procedures are used in the financial audit to assist in the understanding of business operations and in the identification of potential risk areas that need to be addressed. In other words, they are actions taken by auditors to understand the company’s finances, operating environment, and history.
What Does Analytical Procedures Mean?
Auditors perform these assessments to compare financial statements and expected relationships between financial and non-financial data in an effort to find inconsistencies. Fluctuations in the expected data relationships could point the auditors to some type of misrepresentation or fraudulent reporting by the company’s management.
Auditors also use this assessment to projected financial data as well the review of historical financial information.
Let’s look at an example.
Freddie is an auditor at company Y and he is asked to determine potential risk areas. Freddie believes that the implementation of AP is the most efficient tool in his effort to understand the business operation and lower the risk of misstatements in the financial statements to the lowest acceptable level.
Here are the steps that Freddie takes in the process:
- He designs the analytical procedures taking into account the GAAP standards.
- He determines the appropriateness of procedures for given claims, considering particular risks associated with the business’s operations.
- He assesses the reliability of financial data to calculate financial ratiosand compare them to those of previous fiscal years to draw conclusions.
- He assesses the importance of information available.
- He assesses whether his projections are sufficiently precise.
- He calculates any discrepancies of recorded amounts from expected values.
- He reaches a firm conclusion with respect to the consistency of financial statements with his understanding of the business.
- If he identifies inconsistencies and/or fluctuations between the projected and the actual values by a significant amount, he is required to investigate the differences by reaching out to the firm’s management.
An inconsistency that Freddie might find is cash balances that don’t match income and expense reports. For example, the company might report excessively high income and low expenses for the year in an effort to increase investor interest in the company, but the cash flows might tell a different story.