Analytical procedures
From Wikicpa
The use of analytical procedures can be considered a process that consists of four phases. The first phase is the expectation-formation process. In this phase, the auditor forms an expectation of an account balance or financial relationship. In doing so, the auditor determines the precision of the expectation and thus, in part, the effectiveness of the analytical procedure.
The remaining three phases consist of the identification, investigation, and evaluation of the difference between the auditor's expected value and the recorded book value in light of the auditor's materiality assessment. In the second phase, identification, the auditor identifies whether an unusual fluctuation exists between the expected and recorded amounts. In the third, investigation, the auditor investigates the cause of unexpected differences by considering possible causes and searching for information to identify the most probable causes. Finally, in the evaluation phase, the auditor evaluates the likelihood of material misstatement and determines the nature and extent of any additional auditing procedures that may be required.
Expectation Formation (Phase I)
Forming an expectation is the most important phase of the analytical procedure process. The more precise the expectation (that is, the closer the auditor's expectation is to the correct balance or relationship), the more effective the procedure will be at identifying potential misstatements. Also, SAS No. 56 requires the auditor to form an expectation whenever he or she applies analytical procedures.
Identification and Investigation (Phases II and III)
The next two phases of the analytical procedure process consist of identification and investigation. Identification begins by comparing the auditor's expected value with the recorded amount. Given that the auditor developed an expectation with a particular materiality threshold in mind, he or she then compares the unexpected differences with the threshold. In substantive testing, an auditor testing for the possible misstatement of the book value of an account determines whether the audit difference was less than the auditor's materiality threshold. If the difference is less than the acceptable threshold, taking into consideration the desired level of assurance from the procedure, the auditor accepts the book value without further investigation. If the difference is greater, the next step is to investigate the difference.
Evaluation (Phase IV)
The final phase of the analytical procedure process consists of evaluating the difference between the auditor's expected value and the recorded amount. It is usually not practicable to identify factors that explain the exact amount of a difference identified for investigation. However, the auditor should attempt to quantify that portion of the difference for which plausible explanations can be obtained and, where appropriate, corroborated and determine that the amount that cannot be explained is sufficiently small to enable him or her to conclude on the absence of material misstatement.
Source: From AICPA Audit Guide: Analytical Procedures, Chapter 1*: "The Use of Analytical Procedures." Copyright © 2005 by American Institute of Certified Public Accountants
