Okay, let's talk about analytical procedures.
Now, with analytical procedures, remember over here we said, audit procedures. Two types,
testive details of accounts transactions, balances and disclosures and analytic procedures,
that's what we're looking at now. Now what are analytical procedures? That's
part of your ICORRIIA. Analytical procedures are the study of data comparisons and relationships.
How information's compare or relate relationships. This is based on the anticipation or expectation
theory. This deals with ratios, ratio analysis. So what we're looking at is how does the number
compare? How does it relate based on the expectation? What did you get versus what did you expect
to get? That tells us that you know what? This account may have changed by more or less
than we expected. So we're going to do this at the beginning of the audit. We're going
to do this at the end of the audit. Because at the beginning, we're going to look at all
the clients transactions. So for example, here's let's say X1, here's
X2, dollar change, percentage change and we're going to set up maybe parameters. We're going
to say, we're looking at all the changes greater than 10,000 dollars and five percent.
Now notice, this is because you may have a change in this account by one million dollars
but it's only one percent. Well that's reasonable. You may have another that's a 42 percent change
but it's only 27 dollars, who cares? Immaterial. What you're looking for is a 17,000 dollar
change. That's maybe nine percent. You know what? That exceeds both 10,000 and five percent.
That's something that maybe we didn't expect. So when planning the audit you sit down and
you go, you know what? In looking at the changes, this is current year, prior year, PY. So here's
current year, here's PY which means prior year. You know what? This change is bigger
than we expected, then we anticipated. So what we need to do is go back and go, you
know? It changed by more than we thought. Is that reasonable? Or could there be a mistake?
At the end of the audit you do the same thing. Because as I mentioned earlier, this is called
test of details. This is when you're looking at the detail and you're looking but the problem
is you get lost when you can't see the forest for the trees. Because you're in the detail
of the trees. Step back and see the whole forest and go, in the details of the trees,
this one transaction, let me ask questions, let me confirm, let me observe, let me recalculate,
let me reperform it, let me look at the document, look at the assets, let me do that on this
one transaction but when you step back and the whole account balance you go, does this
make sense? Does this change seem reasonable? That's comparing. That is relationships. So
the comparison, relationships, anticipation, expectation, ratio analysis. That's an important
concept, ratio analysis. Now, in looking at the ratio analysis, there's
a couple of different comparisons you can do. Now another mnemonic or memory aid is
CRAFT, meaning client versus industry. So one of the things we do is what is the client
versus the industry standard? So for example, maybe we're looking at client
sales and we're looking at how it compares to revenues of competitors. Related accounts
so for example, how does the change in interest expense affected by changes in notes payable,
loans payable, bonds payable? I mean you expect a correlation right? If I've got a home mortgage
at five percent then you expect your interest expense to be, you know, based on that.
So if interest expense goes up and down but this hasn't changed, there's a problem there.
Actual versus budget again, actual what did you expect versus what did you get. Maybe
things that don't change, maybe payroll expense. Payroll expense, unless you hire or fire a
lot of people, should be pretty consistent. If everybody got a three percent raise then
payroll expense should go up by about three percent. If it goes up by 13 percent, you
go, wait a sec, maybe there's a mistake there. Financial versus nonfinancial. Airlines might
say number of passengers versus total airline revenues. So they're saying, okay let's look
at the passengers, the revenues, and kind of compare that. Current year versus prior
year. This year, prior year. So let's look at, for example, income statement amounts
this year versus prior year. Now, a questions that's come up. What is better
for analytical procedures, balance sheet or income statement? Hmm, balance sheet or income
statement, let's think about it. The balance sheet is what? Cumulative, right? Beginning
cash plus change in cash equals ending cash but it's cumulative, the ending includes the
beginning. Whereas an income statement is this year only, this year only.
So, income statements are better for analytical procedures because balance sheets change day
to day to day, where the income statement you expect there to be some consistency throughout
the year. If I look at total sales this year versus costs of goods sold, the percentage
should be similar next year and next year and next year. Sales should stay pretty consistent
or maybe go up every year but we're going to look at that whereas cash, a balance sheet
account. Let's say December 31st I get a huge amount
of prepayment, cash goes way up. Maybe I've made a prepayment, cash goes way down. So
you can play with those balance sheet numbers pretty easily whereas your income is accrual
basis right? It's an accrual world, we're using accrual accounting which we'll learn
in financial and in regulation as well for tax purposes, cash versus accrual but basically
accrual basically says we're looking at the money earned whether you received it or not.
Whereas cash is what you receive, what you've paid. So that's why one of the questions,
what do you think is better for ratios? Is it balance sheet or income statement? Generally,
income statement.