Audit Method: Analytical Procedures

The substantive analytical procedures (SAP) are one of the weakest points in audit program when it is come to execution. The authorities both in USA and UK when conducting review of audit work like to point on inappropriateness of evidence gained from analytical procedures.

Generally, the mistakes made when performing analytical procedures are as follows:

1. Insufficient reliability of data used in analytical procedures. For example, the data of average sales per employee taken from not independent source, a client representative. The information should be checked before used in our calculations.

2. Expectations regarding tendencies are not well elaborated and/or not based on understanding of  client business. For example, very often for PL analytics general expectation is used that sales/expenses are expected to grow same level as prior year or to be on the same level as prior year, which is not correct by default.

3. Analytical procedures might be performed well, but insufficient on it is own. Usually the procedures could be limited to SAP in case test of controls (TOC) are effective. But in real life the situation may be different:

• TOCs are effective but there are some material items within account, that may change picture completely and, hence, need to be tested;
• The account balance has significant risk, which means that SAP is not sufficient on its own and should be accompanied by test of details.
• When TOCs are ineffective, then we might talk only about application of SAP for the areas of audit where test of details were performed as well

My special comment to an audit firm new joiners: please, be aware when you are questioning client regarding changes in the account balance and then document explanations. I am sure you have a good guidance in your firm on how to perform inquiries and SAP. Moreover, there are a lot of instructions in internet on this issue.  Please, do not write comments like this, which might be then published in Thomas Houck book*: “Sales increased because the client sold more goods”. He refers sarcastically about these type of explanation as “stellar analytical explanation”. The focus of analytics should be real business reason of change in figures.

*Thomas P. Cook. Why and How Audits Must Change:  Practical guidance

News from Airstrip One: Promotions case

The investigation has been opened regarding integrity of promotions in the audit firm KTC33. The investigation was triggered by the embarrassing fact about the audit partner in KTC33 who advocated for promotion of one of his mistresses (Jenny): from audit manager to senior manager. The interesting moment is that the fact was reported to the firm management by his another lover (Kelly). She was jealous of what was happening and decided to revenge. Kelly reported of number of similar cases when promotion  was gained “through bed” or other non-professional activities regarding other partners. Our correspondent, Rob, asked for the comments from audit specialist, Mr Task, in the city of Airstrip One:

• Rob: What could be done to prevent such cases in the Oceanian audit firms? Should firms inspire whistleblowing in case of any relations at job?

• Mr Task: I do not think we need to inspire unnecessary whistleblowing. People might become too focused on somebody’s sins and not on their own. What I suggest we can put some procedures to mitigate such risks. For example, we might establish system where voice of one or two partners would not be decisive. I think, the investigation is just invitation for broader discussion about the systems used by audit firms to assess employees.

Disclaimer: all situations and names in this blog post are not real.

Week-end: Monty Python

Here is a video from old good Monty Python on audit! I liked this joke, sounds all old good British and rather funny J

I wonder what was the audit firm's materiality basis on that engagement with such profit??? J

Audit Method: list of information requests

A list of information requests (LIR) is method to establish common understanding with audit client: what documents need to be prepared in order to progress with audit. The LIR also known in different audit firms as list of outstanding items, client assistance schedule, prepared by client (PBC) list. LIR is one of the project management tools when auditors track if all required information was provided in appropriate quality and on time.

In theory LIR needs to be very specific and at least have following characteristics: detailed description of the request (e.g. it should mention specific account in trial balance), auditor and client employee responsible for request processing, date when information due, format and if applicable prior year example.

I can give following tips on managing LIRs:

1. I advise to use Excel in managing LIRs;
2. The level of details in LIR depends on client: when client is difficult to manage, it might be better to add some more details to be always ready to answer specific questions;
3. The request should be ideally sent 2-3 weeks before start of the engagement, depending on the timing of audit procedures;
4. The auditor must meet and discuss LIR with client representative in charge of the audit after sending the first version of LIR. The protocols of  communication would depend on arrangements with client: e.g. the client might prefer the auditors to work directly with each responsible person in LIR;
5. LIR should be compared with status of audit work at list once a week. I would propose following formula: information received – information processed = unprocessed audit evidence. If there is a lot of unprocessed evidence then it raises questions if audit team have issues with adequate staffing in terms of time and skills of team members.
6.  LIR should be designed in the way to be able to support audit teams in calculating overruns and defend auditors’ position. This could be achieved by updating LIR once a week, calculating number of days/hours from the due date to current date.
7. Regular LIR status calls with client should be organised. All audit team members should participate being ready to provide an update on their section of Audit.

News from Airstrip One: Toxiba case

Toxiba company, one of the biggest in the region of Eurasia, apologised for using fraudulent methods of inflating its profit. The company artificially increased its profits by USD 1.2 bln during preceding 7 years.  The technique of defrauding financial statements was not innovative and referred by Capitalist (magazine in Oceania) as “101”. This usually includes overstating net revenues, booking early revenues and postponing expenses. The company had the auditor R&U, which failed to detected fraud. R&U is multinational company founded in Oceania, having offices in all big cities, including Airstrip One. Our correspondent, Rob, asked for the comments from the audit specialist, Mr Ask, in the city of Airstrip One:

• Rob: What could be done to prevent such cases?
• Mr Task: Well, first of all the corporate culture in Eurasia should change towards being more open and this depends from tone at the top. Second, I think the auditors from R&U should review their fraud detection and cut-off procedures, and then, question themselves, why they were not able to find the intentionally made errors.

Disclaimer: all situations and names is this blog post are not real.

Group and Statutory Audit tailoring

Hi there! Today we are going to talk about combination of two audits (let them be G&S in this blog post): a group and statutory audit. It’s not uncommon to perform them one after in another.

Both auditors and clients want to use synergy of two audits. The value for clients to be serviced by one firm for G&S is saved company’s time/efforts spent for audit and decreased combined price. An  auditor wins by decreasing costs of doing audit and improving realisation rates. However these benefits could be jeopardised by incorrect selection of approach to materiality and scope. There is a necessity to align and methodologically tailor both type of audits. There are number of issues which might differ and impact our samples and scope: materiality, risks (as well as new risks might appear by the time statutory audit starts or whichever is going to be the second), and accounts in scope.

The problem I see here is time lag between these assignments. Sometimes it’s unclear what surprises might appear in statutory accounts after G audit. Primary team instructions and activity also play a big role here.

As in case of multilocation audits I think that methodology should be developed for the purposes of combined (G&S) audit as well.

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