The World Has Changed—Have Analytical Procedure Practices?*

Abstract

Analytical Procedures (APs) provide a means for auditors to evaluate the ''reasonableness'' of financial disclosures by comparing a client's reported performance to expectations gained through knowledge of the client based on past experience and developments within the company and its industry. Thus, APs are fundamentally different than other audit tests in taking a broader perspective of an entity's performance vis-a`-vis its environment. As such, APs have been found to be a cost-effective means to detect misstatements, and many have argued that a number of prior financial frauds would have been detected had auditors employed effective APs. With several dramatic and far-reaching developments over the past decade, the current study examines whether and how APs have changed during this period. In particular, we focus on the impact of significant ''enablers'' and ''drivers'' of change such as technological advancements and the enactment of the Sarbanes-Oxley Act. We also compare our findings to an influential study of the practices of APs by Hirst and Koonce (1996) that was conducted over 10 years ago. We interview 36 auditors (11 seniors, 13 managers, and 12 partners) from all of the Big 4 firms using a structured questionnaire. The data reveal some similarities in findings when compared to prior research (e.g., auditors continue to use fairly simple analytical procedures). However, there are a number of significant differences reflecting changes in AP practices. For instance, as a result of technology auditors now rely more extensively on industry and analyst data than previously. Further, auditors report that they develop more precise quantitative expectations and use more nonfinancial information. They also appear to rely more on lower level audit staff to perform APs, conduct greater inquiry of non-accounting personnel, and are willing to reduce substantive testing to a greater extent as a result of APs conducted in the planning phase. Finally, the Sarbanes-Oxley Act has had an impact in greater consideration and knowledge of internal controls, which is seen as the most important factor driving the use and reliance on APs.

Auditors’ Usage of Non-Financial Data and Information during the Assessment of the Risk of Material Misstatement for an Audit Engagement: A Field Study

“…Hirst and Koonce (1996) documented that auditors in the past did not use non-financial data and information during the performance of analytical procedures. Trompeter and Wright (2010) extended the work of Hirst and Koonce (1996) and mentioned that auditors reported moderate use of non-financial data and information during the performance of analytical procedures, but still prefer to depend on prior years account balances when developing expectations for current year account balances. Brazel et al (2014) documented that only a minority of senior auditors choose to depend on non-financial measures when evaluating revenue account balances via analytical procedures.…”

“…Examples of sources of information that may be approached by an auditor include asking other members of the audit team, generating self-explanations, checking prior years' work papers, and inquiring the client personnel. Results of Hirst and Koonce (1996), as well as Trompeter and Wright (2010), indicated that client personnel inquiry is the primary source of information used by auditors to find explanations for unexpected results got from analytical procedures during the planning of an audit. Of course, this would be a matter of concern if auditors do not subject the explanations of the client personnel to further investigation to check its reasonableness.…”

“…As a result, if auditors are performing analytical procedures that depend on financial data only, they may not discover that the company's financial statements are misstated. Since the manipulated financial data, in this case, would yield auditors' expectations that confirm the company's accounts balances and require no further attention from the auditors (Trompeter & Wright, 2010).…”

“…However, prior research emphasized that auditors tend to rely heavily on financial data and information when assessing the risk of material misstatement during an audit (Erickson, Mayhew, & Felix, 2000;Cohen, Krishnamoorthy, & Wright, 2000;Trompeter & Wright, 2010;Brazel et al, 2014). Accordingly, auditors may fail to recognize unusual trends and/or ratios within the financial statements of an audit client that may serve as a sign of the existence of misstatements (Brazel et al, 2009).…”

“…Accordingly, auditors may fail to recognize unusual trends and/or ratios within the financial statements of an audit client that may serve as a sign of the existence of misstatements (Brazel et al, 2009). In addition, previous research showed that auditors generally do not self-generate explanations for unusual trends and ratios uncovered in the financial statements of their audit clients and they tend to depend on the explanations provided by the staff members of the audit client without performing sufficient work to test the validity of the explanations provided by the client personnel (Hirst & Koonce, 1996;Trompeter & Wright, 2010). …”