ISA 520 Proposed SAS AU Section 329 Comments

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1 The following is a comparison of International Standard on Auditing (ISA) 520, Analytical Procedures; the proposed Statement on Auditing Standards (SAS) Analytical Procedures (Redrafted); and extant AU section 329, Analytical Procedures (AICPA, Professional Standards, vol. 1). The column containing ISA 520 lists the ISA in numerical order. The column containing the proposed SAS contains ISA 520, which was used as the basis for the proposed SAS, marked to show differences in language between the ISA and the proposed SAS (new and deleted material are shown in colored track changes). The column containing the extant AU section 329 contains the requirements and guidance in extant AU section 329 mapped against the proposed SAS in order to demonstrate how the material in AU section 329 has been reflected in the proposed SAS. The column containing comments includes explanations and rationales for substantive changes that have been made in the proposed SAS. Introduction Introduction Scope of this ISA 1. This International Standard on Auditing (ISA) deals with the auditor s use of analytical procedures as substantive procedures ( substantive analytical procedures ). It also deals with the auditor s responsibility to perform analytical procedures near the end of the audit that assist the auditor when forming an overall Scope of this Proposed Statement on Auditing StandardsISA 1. This proposed International StandardStatement on Auditing Standards (ISASAS) deals withaddresses the auditor s use of analytical procedures as substantive procedures ( substantive analytical procedures ). It also deals withaddresses the auditor s responsibility to perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion on the financial statements. ISA 315 Proposed SAS Understanding the Entity and Its Environment and Assessing the Risks of.01 This section provides guidance on the use of analytical procedures and requires the use of analytical procedures in the planning and overall review stages of all audits. The ASB concluded that planning analytics are appropriately covered in the proposed SAS Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement (Redrafted). Page 1 of 40

2 fn 1 conclusion on the Material Misstatement deals financial statements. ISA 315 fn 1 deals with the use of analytical procedures as risk assessment procedures. ISA 330 includes requirements and guidance regarding the nature, timing and extent of audit procedures in response to assessed risks; these audit procedures may include substantive analytical procedures. fn 2 fn 1 ISA 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment, paragraphs 6(b). withaddresses the use of analytical procedures as risk assessment procedures. ISA 330 Proposed SAS Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained includes requirements and guidance regardingaddresses the nature, timing and extent of audit procedures in response to assessed risks; these audit procedures may include substantive analytical procedures. fn 2 fn 1 See paragraph 6(b) of proposed Statement on Auditing Standards (SAS) Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement (Redrafted). ISA 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment, paragraphs 6(b). fn 2 ISA 330, The Auditor s Reponses to Assessed Risks, paragraphs 6 and 18. fn 2 See paragraphs 6 and 19 of proposed SAS Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained (Redrafted).ISA 330, The Auditor s Reponses to Assessed Risks, paragraphs 6 and 18. Page 2 of 40

3 Effective Date Effective Date Effective Date 2. This ISA is effective for audits of financial statements for periods beginning on or after December 15, This ISASAS is effective for audits of financial statements for periods beginning on or after December 15, fn * fn * This date is provisional, but will not be earlier than December 15, This section is effective for audits of financial statements for periods beginning on or after January 1, Early application of the provisions of this section is permissible..03 Understanding financial relationships is essential in planning and evaluating the results of analytical procedures, and generally requires knowledge of the client and the industry or industries in which the client operates. An understanding of the purposes of analytical procedures and the limitations of those procedures is also important. Accordingly, the identification of the relationships and types of data used, as well as conclusions reached when recorded amounts are compared to expectations, requires judgment by the auditor. The first part of the paragraph is covered in paragraphs A10 A11, and the last part is covered in A6. Page 3 of 40

4 Objectives 3. The objectives of the auditor are: Objectives 3. The objectives of the auditor are: (From.04) Analytical procedures are used for the following purposes: (a) To obtain relevant and reliable audit evidence when using substantive analytical procedures; and (a.) tto obtain relevant and reliable audit evidence when using substantive analytical procedures; and (From.04) Analytical procedures are used for the following purposes: b. As a substantive test to obtain audit evidence about particular assertions related to account balances or classes of transactions (b) To design and perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion as to whether the (b). tto design and perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the (From.04) Analytical procedures are used for the following purposes: c. As an overall review of the financial information in the final review stage of the audit The difference in wording is not intended to indicate a difference in the auditor s objective. The ASB determined that the wording in the proposed SAS is Page 4 of 40

5 financial statements auditor s understanding of clearer and provides are consistent with the entityare intended to more appropriate the auditor s corroborate audit evidence understanding of the entity. obtained during the audit of the financial statements to assist the auditor in drawing reasonable conclusions on which to base the auditor s opinion. (From.23) The objective of analytical procedures used in the overall review stage of the audit is to assist the auditor in assessing the conclusions reached and in the evaluation of the overall financial statement presentation. direction to the auditor about the purpose of these types of analytical procedures. Definition Definition 4. For the purposes of the ISAs, the term analytical procedures means evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or 4. For the purposes of the ISAsgenerally accepted auditing standards, the term analytical procedures means evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation, as is necessary, of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. (Ref: Parapar. A1-A3A5) (From.02) Analytical procedures are an important part of the audit process and consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. Particular conditions that can cause variations in these relationships include, for example, specific unusual transactions or events, accounting changes, business changes, random fluctuations, or misstatements. The ASB determined that the last sentence from AU should be included in paragraph A5 as additional application material. Page 5 of 40

6 that differ from expected values by a significant amount. (Ref: Para. A1-A3) Analytical Procedures in Planning the Audit.06 The purpose of applying analytical procedures in planning the audit is to assist in planning the nature, timing, and extent of auditing procedures that will be used to obtain audit evidence for specific account balances or classes of transactions. To accomplish this, the analytical procedures used in planning the audit should focus on (a) enhancing the auditor's understanding of the client's business and the transactions and events that have occurred since the last audit date, and (b) identifying areas that may represent specific risks relevant to the audit. Thus, the objective of the procedures is to identify such things as the existence of As stated in paragraph 1 of the proposed SAS, the use of analytical procedures as risk assessment procedures is addressed in proposed SAS Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement. Page 6 of 40

7 unusual transactions and events, and amounts, ratios and trends that might indicate matters that have financial statement and audit planning ramifications..07 Analytical procedures used in planning the audit generally use data aggregated at a high level. Furthermore, the sophistication, extent and timing of the procedures, which are based on the auditor's judgment, may vary widely depending on the size and complexity of the client. For some entities, the procedures may consist of reviewing changes in account balances from the prior to the current year using the general ledger or the auditor's preliminary or unadjusted working trial balance. In contrast, for other entities, the procedures might involve an extensive analysis of quarterly financial statements. In both cases, the analytical procedures, combined with the auditor's As stated in paragraph 1 of the proposed SAS, the use of analytical procedures as risk assessment procedures is addressed in proposed SAS Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement. Page 7 of 40

8 knowledge of the business, serve as a basis for additional inquiries and effective planning..08 Although analytical procedures used in planning the audit often use only financial data, sometimes relevant nonfinancial information is considered as well. For example, number of employees, square footage of selling space, volume of goods produced, and similar information may contribute to accomplishing the purpose of the procedures. As stated in paragraph 1 of the proposed SAS, the use of analytical procedures as risk assessment procedures is addressed in proposed SAS Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement. Requirements Substantive Procedures Analytical 5. When designing and performing substantive analytical procedures, either alone or in combination with tests of details, as Requirements Substantive Analytical Procedures 5. When designing and performing substantive analytical procedures, either alone or in combination with tests of details, as substantive procedures in accordance with ISA 330 proposed SAS Performing Audit Page 8 of 40

9 substantive procedures Procedures in Response to Assessed in accordance with ISA Risks and Evaluating the Audit 330, fn 3 the auditor Evidence Obtained, fn 3 the auditor shall: (Ref: Para. A4-A5) shallshould: (Ref: Parapar. A54-A75) fn 3 ISA 330, paragraph 18. fn 3 See paragraph 19 of proposed SAS Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained.ISA 330, paragraph 18. (a) Determine the suitability of particular substantive analytical procedures for given assertions, taking account of the assessed risks of material misstatement and tests of details, if any, for these assertions; (Ref: Para. A6-A11) (b) Evaluate the reliability of data from which the (a). Ddetermine the suitability of particular substantive analytical procedures for given assertions, taking into account of the assessed risks of material misstatement and tests of details, if any, for these assertions; (Ref: Parapar. A6- A1A9-A151) (b). Eevaluate the reliability of data from which the auditor s expectation of (From.04) In addition, in some cases, analytical procedures can be more effective or efficient than tests of details for achieving particular substantive testing objectives. (From.16) The reliability of the data used to develop the expectations should be The task force concluded that the requirements in AU Page 9 of 40

10 auditor s expectation of recorded amounts or ratios is developed, taking account of source, comparability, and nature and relevance of information available, and controls over preparation; (Ref: Para. A12-A14) (c) Develop an expectation of recorded amounts or ratios and evaluate whether the expectation is sufficiently precise to identify a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be recorded amounts or ratios is developed, taking into account of source, comparability, and nature and relevance of information available, and controls over preparation; (Ref: Parapar. A12-A14A16- A19) (c) Ddevelop an expectation of recorded amounts or ratios and evaluate whether the expectation is sufficiently preciseto, when, either alone or, if applicable, combined with audit evidence from other audit procedures, to identify a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated; appropriate for the desired level of assurance from the analytical procedure. The auditor should assess the reliability of the data by considering the source of the data and the conditions under which it was gathered, as well as other knowledge the auditor may have about the data. (From.16) The auditor obtains assurance from analytical procedures based upon the consistency of the recorded amounts with expectations developed from data derived from other sources. (From.17) The expectation should be precise enough to provide the desired level of assurance that differences that may be potential material misstatements, individually or when aggregated with other misstatements, would be are encompassed in (b). The ASB included the added language to clarify that the auditor can use a substantive analytical procedure that is less precise than performance materiality as audit evidence. Page 10 of 40

11 materially misstated; and (Ref: Para. A15) and (Ref: Parapar. A15A20- A21) identified for the auditor to investigate (see paragraph.20). (d) Determine the amount of any difference of recorded amounts from expected values that is acceptable without further investigation as required by paragraph 7. (Ref: Para. A16) (d. ) Ddetermine the amount of any difference of recorded amounts from expected values that is acceptable without further investigation as required by paragraph 7. (Ref: Parapar. A10 and A22A16) (From.20) In planning the analytical procedures as a substantive test, the auditor should consider the amount of difference from the expectation that can be accepted without further investigation. Analytical Procedures that Assist When Forming an Overall Conclusion 6. The auditor shall design and perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the Analytical Procedures tthat Assist When Forming an Overall Conclusion 6. The auditor shallshould design and perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the auditor s understanding of the entityare intended to corroborate audit evidence obtained during the audit of the financial statements to assist the auditor in (From.04) Analytical procedures are used for the following purposes: c. As an overall review of the financial information in the final review stage of the audit The ASB determined to clarify the intent of analytical procedures performed near the end of the audit. Page 11 of 40

12 auditor s understanding of the entity. (Ref: Para. A17-A19) drawing reasonable conclusions on which to base the auditor s opinion. (Ref: Parapar. A17A23-A25-A19)) Investigating Results of Analytical Procedures 7. If analytical procedures performed in accordance with this ISA identify fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount, the auditor shall investigate such differences by: Investigating Results of Analytical Procedures 7. If analytical procedures performed in accordance with this proposed ISASAS identify fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount, the auditor shallshould investigate such differences by: (From.21) The auditor should evaluate significant unexpected differences. (a) Inquiring of management and obtaining appropriate audit evidence relevant to management s responses; and (a). Inquiring inquiring of management and obtaining appropriate audit evidence relevant to management s responses; and (From.21) Reconsidering the methods and factors used in developing the expectation and inquiry of management may assist the auditor in this regard. Page 12 of 40

13 (b) Performing other audit procedures as necessary in the circumstances. (Ref: Para. A20-A21) (b). Performing performing other audit procedures as necessary in the circumstances. (Ref: Parapar. A205-A216) (From.21) In those cases when an explanation for the difference cannot be obtained, the auditor should obtain sufficient appropriate audit evidence about the assertion by performing other audit procedures to satisfy himself as to whether the difference is a likely misstatement. fn 3 fn 3 See section Documentation of Substantive Analytical Procedures 8. When using a substantive analytical procedure, the auditor should document (a) the expectation referred to in paragraph 5(c), when that expectation is not otherwise readily determinable from the documentation of the work performed, and factors considered in its development; (b) results of the comparison of the expectation to the recorded amounts referred to in Documentation of Substantive Analytical Procedures.22 When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor should document all of the following: a. The expectation, where that expectation is not otherwise readily determinable from the documentation of the work performed, and factors considered in its The ASB determined that the documentation requirements contained in extant AU 329 are appropriate and should be retained in the proposed SAS. Page 13 of 40

14 paragraph 5 or ratios developed from recorded amounts; and (c) any additional auditing procedures performed in accordance with paragraph 7 relating to fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. development b. Results of the comparison of the expectation to the recorded amounts or ratios developed from recorded amounts c. Any additional auditing procedures performed in response to significant unexpected differences arising from the analytical procedure and the results of such additional procedures Application and Other Explanatory Material Definition of Analytical Procedures (Ref: Para. 4) A1. Analytical procedures include the consideration of comparisons of the entity s financial information with, for example: Application and Other Explanatory Material Definition of Analytical Procedures (Ref: Parapar. 4) A1. Analytical procedures include the consideration of comparisons of the entity s financial information with, for example,: (From.05) Analytical procedures involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor. Following are Page 14 of 40

15 examples of sources of information for developing expectations: Comparable information for prior periods. Comparable comparable information for prior periods. (From.05) Following are examples of sources of information for developing expectations: a. Financial information for comparable prior period(s) giving consideration to known changes Anticipated results of the entity, such as budgets or forecasts, or expectations of the auditor, such as an estimation of depreciation. Anticipated anticipated results of the entity, such as budgets or forecasts, or expectations of the auditor, such as an estimation of depreciation. (From.05) Following are examples of sources of information for developing expectations: b. Anticipated results for example, budgets, or forecasts including extrapolations from interim or annual data Page 15 of 40

16 Similar industry information, such as a comparison of the entity s ratio of sales to accounts receivable with industry averages or with other entities of comparable size in the same industry. A2. Analytical procedures also include consideration of relationships, for example: Among elements of financial information that would be expected Similar similar industry information, such as a comparison of the entity s ratio of sales to accounts receivable with industry averages or with other entities of comparable size in the same industry. A2. Analytical procedures also include consideration of relationships,; for example,: Among among elements of financial information that would be expected to conform (From.05) Following are examples of sources of information for developing expectations: d. Information regarding the industry in which the client operates for example, gross margin information (From.05) The auditor develops such expectations by identifying and using plausible relationships that are reasonably expected to exist based on the auditor's understanding of the client and of the industry in which the client operates. Following are examples of sources of information for developing expectations: (From.05) The auditor develops such expectations by identifying and using plausible The task force considered adding the for example, gross margin information to the proposed SAS. However, the task force concluded that since the first bullet of paragraph A2 references gross margin percentages, it is probably not necessary (although context is different). The task force concluded that the first sentence from extant AU 329 is covered by the third bullet in paragraph A1. Page 16 of 40

17 to conform to a predictable pattern based on the entity s experience, such as gross margin percentages. to a predictable pattern based on the entity s experience, such as gross margin percentages. relationships that are reasonably expected to exist based on the auditor's understanding of the client and of the industry in which the client operates. Following are examples of sources of information for developing expectations: c. Relationships among elements of financial information within the period Between financial information and relevant non-financial information, such as payroll costs to number of employees. Between between financial information and relevant nonfinancial information, such as payroll costs to number of employees. (From.05) The auditor develops such expectations by identifying and using plausible relationships that are reasonably expected to exist based on the auditor's understanding of the client and of the industry in which the client operates. Following are examples of sources of information for developing expectations: e. Relationships of financial Page 17 of 40

18 information with relevant nonfinancial information A3. Various methods may be used to perform analytical procedures. These methods range from performing simple comparisons to performing complex analyses using advanced statistical techniques. Analytical procedures may be applied to consolidated financial statements, components and individual elements of information. A3. Various methods may be used to perform analytical procedures. These methods range from performing simple comparisons to performing complex analyses using advanced statistical techniques. Analytical procedures may be applied to consolidated financial statements, components and individual elements of information. (From.02) Analytical procedures range from simple comparisons to the use of complex models involving many relationships and elements of data. A4. Scanning is a type of analytical procedure involving the auditor s use of professional judgment to review accounting data to identify significant or unusual items. This type of analytical procedure is described further in paragraph A22 of clarified SAS, Audit Evidence. A5. A basic premise underlying the application of analytical procedures is that plausible relationships among data may reasonably be expected to exist (From.02) A basic premise underlying the application of analytical procedures is that plausible relationships among The ASB determined that the guidance from paragraph A22 from the clarified SAS Audit Evidence should be referenced in the proposed SAS. The ASB concluded that the guidance in AU and AU is important to Page 18 of 40

19 and continue in the absence of known conditions to the contrary. The reasons that make relationships plausible are an data may reasonably be expected to exist and continue in the absence of known conditions to retain the important consideration as data the contrary. sometimes appears to be related when it is not, which may lead the auditor to erroneous conclusions. In addition, the presence of an unexpected relationship can provide important evidence when appropriately scrutinized..13 It is important for the auditor to understand the reasons that make relationships plausible because data sometimes appear to be related when they are not, which could lead the auditor to erroneous conclusions. In addition, the presence of an unexpected relationship can provide important evidence when appropriately scrutinized. language was revised to conform with the ASB s clarity drafting conventions. The first sentence is from AU Substantive Analytical Procedures (Ref: Para. 5) Substantive Analytical Procedures (Ref: Parapar. 5) Analytical Procedures Used as Substantive Tests A4. The auditor s substantive procedures at the assertion level may be tests of details, substantive analytical procedures, or a combination of both. The decision about which audit procedures to perform, including whether to use substantive analytical procedures, is based on the A4A6. The auditor s substantive procedures to address the risk of material misstatement for relevant at the assertions level may be tests of details, substantive analytical procedures, or a combination of both. The decision about which audit procedures to perform, including whether to use substantive analytical procedures, is based on the auditor s.09 The auditor's reliance on substantive tests to achieve an audit objective related to a particular assertion [footnote 1 is included in Definitions] may be derived from tests of details, from analytical procedures, or from a combination of both. The decision about which procedure or procedures to use to achieve a The added language is from AU Page 19 of 40

20 auditor s judgment about the expected effectiveness and efficiency of the available audit procedures to reduce audit risk at the assertion level to an acceptably low level. judgment about the expected effectiveness and efficiency of the available audit procedures to reduce audit risk at the assertion levelthe risk of material misstatement to an acceptably low level. Accordingly, the identification and evaluation of the relationships among the data used in the analytical procedures (including the strength of those relationships), the evaluation of the reliability of the data used in these tests, and the formation of conclusions reached when recorded amounts are compared to expectations, are matters of professional judgment. particular audit objective is based on the auditor's judgment on the expected effectiveness and efficiency of the available procedures. A7. The expected effectiveness and efficiency of a substantive analytical procedure in identifying potential misstatements depends on, among other things, (a) the nature of the assertion, (b) the plausibility and predictability of the relationship, (c) the availability and reliability of the data used to develop the expectation, and (d) the precision of the expectation..11 The expected effectiveness and efficiency of an analytical procedure in identifying potential misstatements depends on, among other things, (a) the nature of the assertion, (b) the plausibility and predictability of the relationship, (c) the availability and reliability of the data used to develop the expectation, and (d) the precision of the expectation. The language in the draft SAS refers to substantive analytical procedures. Page 20 of 40

21 A5. The auditor may inquire of management as to the availability and reliability of information needed to apply substantive analytical procedures, and the results of any such analytical procedures performed by the entity. It may be effective to use analytical data prepared by management, provided the auditor is satisfied that such data is properly prepared. A5A8. The auditor may inquire of management as toabout the availability and reliability of information needed to apply substantive analytical procedures, and the results of any such analytical procedures performed by the entity. It may be effective to use analytical data prepared by management, provided the auditor is satisfied that such data is properly prepared. Suitability of Particular Analytical Procedures for Given Assertions (Ref: Para. 5(a)) Suitability of Particular Analytical Procedures for Given Assertions ([Ref: Parapar. 5(a)))] A9. As more persuasive audit evidence is desired from substantive analytical procedures, more predictable relationships are necessary to develop the expectation. Relationships in a stable environment are usually more predictable than relationships in a dynamic or unstable environment. Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts because Plausibility and Predictability of the Relationship.14 As higher levels of assurance are desired from analytical procedures, more predictable relationships are required to develop the expectation. Relationships in a stable environment are usually more predictable than relationships in a dynamic or unstable environment. Relationships involving income statement accounts tend to be more The language in the proposed SAS refers to substantive analytical procedures. In addition, to adhere to the ASB drafting conventions, the are sometimes wording in the extant SAS was revised to read may be in the proposed SAS. Page 21 of 40

22 A6. Substantive analytical procedures are generally more applicable to large volumes of transactions that tend to be predictable over time. The application of planned analytical procedures is based on the expectation that relationships among data exist and continue in the absence of known conditions to the contrary. However, the suitability of a particular income statement accounts represent transactions over a period of time, whereas balance sheet accounts represent amounts as of a point in time. Relationships involving transactions subject to management discretion may be less predictable. For example, management may elect to incur maintenance expense rather than replace plant and equipment, or they may delay advertising expenditures. A6.A10. Substantive analytical procedures are generally more applicable to large volumes of transactions that tend to be predictable over time. The application of planned analytical procedures is based on the expectation that relationships among data exist and continue in the absence of known conditions to the contrary. However, the suitability of a particular analytical procedure will depend upon the auditor s assessment of how effective it will be in detecting a predictable than relationships involving only balance sheet accounts since income statement accounts represent transactions over a period of time, whereas balance sheet accounts represent amounts as of a point in time. Relationships involving transactions subject to management discretion are sometimes less predictable. For example, management may elect to incur maintenance expense rather than replace plant and equipment, or they may delay advertising expenditures. The ASB determined to refer to more persuasive audit evidence as opposed to higher levels of assurance to be consistent with the terminology included in the clarified risk assessment standards. Page 22 of 40

23 analytical procedure will depend upon the auditor s assessment of how effective it will be in detecting a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated. misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated. Nature of Assertion A7. In some cases, even an unsophisticated predictive model may be effective as an analytical procedure. For example, where an entity has a known number of employees at fixed rates of pay throughout the period, it may be possible for the auditor to use this data to estimate the total payroll costs for the period with a high degree of accuracy, thereby providing audit evidence for a significant item in the financial statements and reducing the need to perform tests of details on the payroll. The use of widely recognized trade ratios A7.A11. In some cases, even an unsophisticated predictive model may be effective as an analytical procedure. For example, where when an entity has a known number of employees at fixed rates of pay throughout the period, it may be possible for the auditor to use this data to estimate the total payroll costs for the period with a high degree of accuracy, thereby providing audit evidence for a significant item in the financial statements and reducing the need to perform tests of details on the payroll. The use of widely recognized trade ratios (such as profit margins for different types of retail entities) can often be used effectively in substantive analytical procedures to provide.12 Analytical procedures may be effective and efficient tests for assertions in which potential misstatements would not be apparent from an examination of the detailed evidence or in which detailed evidence is not readily available. For example, comparisons of aggregate salaries paid with the number of personnel may indicate unauthorized payments that may not be apparent from testing individual transactions. Differences from expected relationships may also indicate potential omissions when independent evidence that an individual transaction should Page 23 of 40

24 (such as profit margins for different types of retail entities) can often be used effectively in substantive analytical procedures to provide evidence to support the reasonableness of recorded amounts. A8. Different types of analytical procedures provide different levels of assurance. Analytical procedures involving, for example, the prediction of total rental income on a building divided into apartments, taking the rental rates, the number of apartments and vacancy rates into consideration, can provide persuasive evidence and may eliminate the need for further verification by means of tests of details, provided the elements are appropriately verified. In contrast, calculation and comparison of gross margin percentages as a means of confirming a revenue figure may provide less persuasive evidence, but may provide evidence to support the reasonableness of recorded amounts. A8.A12. Different types of analytical procedures provide different levels of assurance. Analytical procedures involving, for example, the prediction of total rental income on a building divided into apartments, taking the rental rates, the number of apartments, and vacancy rates into consideration, can provide persuasive evidence and may eliminate the need for further verification by means of tests of details, provided the elements are appropriately verified. In contrast, calculation and comparison of gross margin percentages as a means of confirming a revenue figure may provide less persuasive evidence, but may provide useful corroboration if used in combination with other audit procedures. have been recorded may not be readily available..10 The auditor considers the level of assurance, if any, he wants from substantive testing for a particular audit objective and decides, among other things, which procedure, or combination of procedures, can provide that level of assurance. For some assertions, analytical procedures are effective in providing the appropriate level of assurance. For other assertions, however, analytical procedures may not be as effective or efficient as tests of details in providing the desired level of assurance. Page 24 of 40

25 useful corroboration if used in combination with other audit procedures. A9. The determination of the suitability of particular substantive analytical procedures is influenced by the nature of the assertion and the auditor s assessment of the risk of material misstatement. For example, if controls over sales order processing are deficient, the auditor may place more reliance on tests of details rather than on substantive analytical procedures for assertions related to receivables. A10. Particular substantive analytical procedures may also be considered suitable when tests of details are performed on the same assertion. For example, when obtaining audit evidence regarding the valuation assertion for accounts receivable balances, the auditor may apply analytical procedures to an aging of A9.A13. The determination of the suitability of particular substantive analytical procedures is influenced by the nature of the assertion and the auditor s assessment of the risk of material misstatement. For example, if controls over sales order processing are deficient, the auditor may place more reliance on tests of details rather than on substantive analytical procedures for assertions related to receivables. A10.A14. Particular substantive analytical procedures may also be considered suitable when tests of details are performed on the same assertion. For example, when obtaining audit evidence regarding the valuation assertion for accounts receivable balances, the auditor may apply analytical procedures to an aging of customers accounts in addition to performing tests of details on Page 25 of 40

26 customers accounts in addition to performing tests of details on subsequent cash receipts to determine the collectability of the receivables. subsequent cash receipts to determine the collectability of the receivables. Considerations Specific to Public Sector Entities A11. The relationships between individual financial statement items traditionally considered in the audit of business entities may not always be relevant in the audit of governments or other nonbusiness public sector entities; for example, in many public sector entities there may be little direct relationship between revenue and expenditure. In addition, because expenditure on the acquisition of assets may not be capitalized, there may be no relationship between expenditures on, for example, inventories and fixed assets and the amount of those assets reported in the financial Considerations Specific to Public SectorGovernmental Entities A11.A15. The relationships between individual financial statement items traditionally considered in the audit of business entities may not always be relevant in the audit of governmental entities or not-for-profit organizations or other non-business public sector entities; for example, in many governmental entities or not-for-profit organizationspublic sector entities there may be little direct relationship between revenue and expenditure. In addition, because expenditure on the acquisition of assets may not be capitalized, there may be no relationship between expenditures on, for example, inventories and fixed assets and the amount of those assets reported in the financial statements. Also, industry data or statistics for comparative purposes may not be The ASB determined that the last two sentences are not necessary guidance for governmental entities in the United States. Page 26 of 40

27 statements. Also, industry data or statistics for comparative purposes may not be available in the public sector. However, other relationships may be relevant, for example, variations in the cost per kilometer of road construction or the number of vehicles acquired compared with vehicles retired. available in the public sector. However, other relationships may be relevant, for example, variations in the cost per kilometer mile of road construction or the number of vehicles acquired compared with vehicles retired. The Reliability of the Data (Ref: Para. 5(b)) A12. The reliability of data is influenced by its source and nature and is dependent on the circumstances under which it is obtained. Accordingly, the following are relevant when determining whether data is reliable for purposes of designing substantive analytical procedures: The Reliability of the Data (Ref: Parapar. 5(b)) A12.A16. The reliability of data is influenced by its source and nature and is dependent on the circumstances under which it is obtained. Accordingly, the following are relevant when determining whether data is reliable for purposes of designing substantive analytical procedures: Plausibility and Predictability of the Relationship (From.16) The following factors influence the auditor's consideration of the reliability of data for purposes of achieving audit objectives: (a) Source of the information available. For example, (a). Source of the information available. For example, information may be more (From.16) The following factors influence the auditor's consideration of the reliability of data for purposes of achieving Page 27 of 40

28 information may be reliable when it is obtained audit objectives: more reliable when it is from independent sources obtained from outside the entity;. fn 4 Whether the data was independent sources obtained from outside the entity; fn 4 independent sources fn 4 ISA 500, Audit Evidence, paragraph A31. outside the entity or from See paragraph A32 of proposed SAS Audit sources within the fn 4 ISA 500, Audit Evidence, Evidence (Redrafted). entity paragraph A31. (b) Comparability of the information available. For example, broad industry data may need to be supplemented to be comparable to that of an entity that produces and sells specialized products; (c) Nature and relevance of the information available. For example, whether budgets have been established as results to be expected rather than as goals to be achieved; and (d) Controls over the preparation of the information that are (b). Comparability of the information available. For example, broad industry data may need to be supplemented to be comparable to that of an entity that produces and sells specialized products;. (c). Nature and relevance of the information available. For example, whether budgets have been established as results to be expected rather than as goals to be achieved; and. (d). Controls over the preparation of the information that are designed to ensure its (From.16) The following factors influence the auditor's consideration of the reliability of Page 28 of 40

29 designed to ensure its completeness, accuracy and validity. For example, controls over the preparation, review and maintenance of budgets. completeness, accuracy and validity. For example, controls over the preparation, review and maintenance of budgets. data for purposes of achieving audit objectives: Whether the data was developed under a reliable system with adequate controls... e. Whether the data was subjected to audit testing. (From.16) The following factors influence the auditor's consideration of the reliability of data for purposes of achieving audit objectives: Whether the data was subjected to audit testing in the current or prior year Whether the expectations were developed using data from a variety of sources The ASB concluded that the penultimate bullet from AU should be added as subparagraph (e) but that the words in the current or prior year should be deleted to avoid confusion. A13. The auditor may consider testing the operating A13.A17. The auditor may consider testing the operating effectiveness of Page 29 of 40

30 effectiveness of controls, if any, over the entity s preparation of information used by the auditor in performing substantive analytical procedures in response to assessed risks. When such controls are effective, the auditor generally has greater confidence in the reliability of the information and, therefore, in the results of analytical procedures. The operating effectiveness of controls over non-financial information may often be tested in conjunction with other tests of controls. For example, in establishing controls over the processing of sales invoices, an entity may include controls over the recording of unit sales. In these circumstances, the auditor may test the operating effectiveness of controls over the recording of unit sales in conjunction with tests of the operating effectiveness of controls over the processing of sales invoices. Alternatively, the controls, if any, over the entity s preparation of information used by the auditor in performing substantive analytical procedures in response to assessed risks. When such controls are effective, the auditor generally hasmay have greater confidence in the reliability of the information and, therefore, in the results of analytical procedures. The operating effectiveness of controls over nonfinancial information may often be tested in conjunction with other tests of controls. For example, in establishing controls over the processing of sales invoices, an entity may include controls over the recording of unit sales. In these circumstances, the auditor may test the operating effectiveness of controls over the recording of unit sales in conjunction with tests of the operating effectiveness of controls over the processing of sales invoices. Alternatively, the auditor may consider whether the information was subjected to audit testing. ISA 500Proposed SAS Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained (Redrafted) Page 30 of 40

31 auditor may consider whether the information was subjected to audit testing. ISA 500 (Redrafted) establishes requirements and provides guidance in determining the audit procedures to be performed on the information to be used for substantive analytical procedures. fn 5 fn 5 ISA 500, paragraph 10 A14. The matters discussed in paragraphs A12(a)-A12(d) are relevant irrespective of whether the auditor performs substantive analytical procedures on the entity s period end financial statements, or at an interim date and plans to perform substantive analytical procedures for the remaining period. ISA 330 establishes requirements and provides guidance on substantive procedures fn performed at an interim date. 6 establishes requirements and provides guidance inaddresses determining the audit procedures to be performed on the information to be used for substantive analytical procedures. fn 5 fn 5 See paragraph 8 of proposed SAS Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained (Redrafted).ISA 500, paragraph 10. A14.A18. The matters discussed in paragraphs A162(a)-A162(ed) are relevant irrespective of whether the auditor performs substantive analytical procedures on the entity s period end financial statements, or at an interim date and plans to perform substantive analytical procedures for the remaining period. Proposed SAS Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence ObtainedISA 330 establishes requirements and provides guidance onaddresses performing substantive procedures performed at an interim date. fn 6 Page 31 of 40

32 fn 6 ISA 330, paragraphs fn 6 ISA 330, paragraphs See paragraphs of proposed SAS Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained (Redrafted). A19. When expectations are developed at a detailed level, the auditor generally has a greater chance of detecting misstatements of a given amount than when broad comparisons are used. Monthly amounts may be more effective than annual amounts and comparisons by location or line of business usually are more effective than company-wide comparisons. The level of detail that is appropriate is influenced by the nature of the entity, its size and its complexity. The risk that material misstatement may be obscured by offsetting factors increases as an entity s operations become more complex and more diversified. Disaggregation helps reduce this risk. Availability and Reliability of Data.19 Expectations developed at a detailed level generally have a greater chance of detecting misstatement of a given amount than do broad comparisons. Monthly amounts will generally be more effective than annual amounts and comparisons by location or line of business usually will be more effective than company-wide comparisons. The level of detail that is appropriate will be influenced by the nature of the client, its size and its complexity. Generally, the risk that material misstatement could be obscured by offsetting factors increases as a client's operations become more complex and more diversified. Disaggregation helps reduce this risk. Page 32 of 40