## **Learning Outcomes**

This article explains how auditors use analytical procedures—including ratio and trend analysis—during the planning stage of an audit. You will learn the objectives of these procedures, methods for calculating and interpreting key ratios, and how to use trends and comparisons to identify audit risks. After studying, you should be able to perform basic analytical procedures, interpret their results, and suggest relevant audit responses in line with ACCA AA exam requirements.

## **ACCA Audit and Assurance (AA) Syllabus**

For ACCA Audit and Assurance (AA), you are required to understand the use of analytical procedures as part of risk assessment and audit planning. In particular, you should focus on the following syllabus areas:

- The nature and objective of analytical procedures at the planning stage.
- How to compute and interpret common ratios and trends from financial information.
- The use of analytical procedures to identify areas of significant risk or misstatement in the financial statements.
- How analytical findings inform the design and focus of further audit procedures.
- The incorporation of analytical procedures with the auditor’s understanding of the client and its environment.

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. List three types of comparisons an auditor might make when performing planning-stage analytical procedures.
2. Which ratio would you use to assess the liquidity of an entity, and what does it measure?
3. True or false? Analytical procedures at the planning stage are used to obtain direct audit evidence for account balances.
4. How could an unusually high receivables collection period affect the audit plan?

## **Introduction**

Analytical procedures are required steps in audit planning that help you obtain an initial understanding of the entity and identify areas of potential misstatement. These are performed by comparing financial and non-financial data using ratios, trends, and other relationships to spot inconsistencies or unusual amounts that might signal audit risk.

> **Key Term: analytical procedures**
> Procedures that evaluate financial information by analyzing plausible relationships among data, including comparisons, ratios, and trends, with a focus on identifying unexpected changes, inconsistencies, or areas of risk.

### Objectives of analytical procedures in planning

The aim at the planning stage is not to collect audit evidence for assertions, but rather to highlight unusual or unexpected changes and direct audit effort to higher-risk areas. This process supports risk assessment and decision-making about the nature, timing, and extent of further procedures.

### Common methods of analytical procedures

Analytical procedures can include:

- Year-on-year comparisons of financial statement line items.
- Ratio analysis (e.g., profit margins, liquidity ratios).
- Comparing results to budgets, forecasts, and industry averages.
- Linking financial results to non-financial data (e.g., production levels, staff numbers).

> **Key Term: ratio analysis**
> The calculation and interpretation of selected relationships between elements in the financial statements, such as margins, efficiency, and liquidity, used to assess performance and risk.
>
> **Key Term: trend analysis**
> The evaluation of movements in key financial or non-financial data over several periods to reveal patterns, fluctuations, or anomalies.

### Typical ratios used in audit planning

- **Profitability ratios**: Gross/operating/net profit margin, return on capital employed.
- **Liquidity ratios**: Current ratio, quick ratio.
- **Efficiency ratios**: Inventory holding period, receivables collection period, payables payment period, asset turnover.
- **Gearing ratios**: Debt to equity, interest cover.

The selection of which ratios to apply depends on the nature of the client’s business, current risks, and the auditor’s understanding of what matters most for that entity.

### How analytical procedures are performed at planning

1. **Develop an expectation**: Based on knowledge of the client and its industry, anticipate reasonable figures or relationships.
2. **Compute comparisons/ratios/trends**: Use draft or prior-year financial statements, budgets, or industry data.
3. **Investigate material fluctuations**: Where actual results differ from expectations or trend significantly, consider reasons and discuss with management.
4. **Document findings**: Note any areas identified as higher risk, which will influence the audit strategy and subsequent testing.

### **Worked Example 1.1**

**You are planning the audit of Delta Ltd. The gross profit margin has risen from 18% to 25% over the last year, while sales volume remained stable. What risks or misstatements should you consider?**

> **Answer:** The increase could be due to revenue overstatement (e.g., cut-off errors, premature recognition) or cost of sales understatement (e.g., incomplete recording of purchases, overvalued closing inventory). This should prompt further audit focus on revenue recognition and inventory valuation.

### Interpreting audit findings from analytical procedures

Not all fluctuations indicate error—changes may have valid reasons, such as new business lines, price changes, or macroeconomic shifts. The auditor must use judgement and corroborate explanations with evidence where appropriate.

### When analytical procedures signal risk

Analytical procedures might reveal:

- Unexpected changes (e.g., declining liquidity, margin fluctuations).
- Results inconsistent with industry averages.
- Figures inconsistent with operational data (e.g., payroll expense rises without increase in staff).

Such signals require you to adjust the audit plan (e.g., increase substantive testing, alter sampling, or investigate specific account balances).

### **Worked Example 1.2**

**During planning, you note that receivables as a percentage of sales have increased from 10% to 18%. What should your audit response be?**

> **Answer:** This may indicate collectability problems, relaxed credit control, or revenue manipulation. The auditor should plan for more substantive procedures on receivables, review aged receivables, and test for adequate allowance for doubtful debts.

### Using trend analysis for risk assessment

Trend analysis over multiple periods can highlight gradual changes (e.g., inventory buildup, rising expenses), sudden spikes or falls, or seasonality patterns. Identifying unexplained or inconsistent trends suggests areas requiring further investigation.

### **Exam Warning**

> A common error is assuming that all budget or prior period variances require adjustment or evidence; in fact, only unexplained or unsupported variances that may signal misstatement should prompt additional audit work.

### Limitations of analytical procedures at planning

- Analytical procedures alone do not provide sufficient evidence for most assertions.
- The quality of conclusions depends on the reliability of available data.
- Significant business changes, new products, or economic shocks may invalidate historical comparisons.

### **Revision Tip**

> Focus your analytical procedures on the most significant balances—material revenue or expense lines, volatile figures, and balances with known control weaknesses.

## **Summary**

Analytical procedures at planning are key tools to identify areas of financial statements at greater risk of material misstatement. By calculating and interpreting key ratios and trends, auditors build an expectation and investigate deviations, which helps guide the focus of subsequent audit procedures and informs risk assessment but is not sufficient by itself for testing assertions.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- The purpose of analytical procedures during audit planning.
- How to compute and interpret important ratios and trends.
- How to identify areas of audit risk from analytical findings.
- The types of audit response appropriate when unusual trends or ratios are observed.
- The limitations of analytical procedures at the planning stage.

## **Key Terms and Concepts**

- analytical procedures
- ratio analysis
- trend analysis

Analytical procedures in planning - Ratio and trend analysis