15 The auditor ordinarily designs and performs substantive procedures to be responsive to the related assessment of the risk of material misstatement at the assertion level. The auditor’s substantive procedures at the assertion level may be derived from tests of details, from substantive analytical procedures, or from a combination of both. The decision about which audit procedures to use to achieve a particular audit objective is ordinarily based on the auditor’s judgement about the expected effectiveness and efficiency of the available audit procedures in reducing the assessed risk of material misstatement at the assertion level to an acceptably low level.
16 The auditor will ordinarily enquire of management as to the availability and reliability of information needed to apply substantive analytical procedures, and the results of any such procedures performed by the entity. It may be efficient to use analytical data prepared by the entity, provided the auditor is satisfied that such data is properly prepared.
17 When designing and performing analytical procedures as substantive procedures, the auditor ordinarily will need to consider a number of factors such as the following:
the suitability of using substantive analytical procedures given the assertions (paragraphs 18 and 19);
the reliability of the data, whether internal or external, from which expectation of recorded amounts or ratios is developed (paragraphs 20 and 21);
whether the expectation is sufficiently precise to identify a material misstatement at the desired level of assurance (paragraph 22); and
the amount of any difference of recorded amounts from expected values that is acceptable (paragraph 23).
Suitability of Using Substantive Analytical Procedures Given the Assertions
18 Substantive analytical procedures are generally more applicable to large volumes of transactions that tend to be predictable over time. The application of substantive analytical procedures is based on the expectation that relationships among data exist and continue in the absence of known conditions to the contrary. The presence of these relationships provides audit evidence as to the completeness, accuracy and occurrence of transactions captured in the information produced by the entity’s information system. However, reliance on the results of substantive analytical procedures will ordinarily depend on the auditor’s assessment of the risk that the analytical procedures may identify relationships as expected when, in fact, a material misstatement exists.
19 In determining the suitability of substantive analytical procedures given the assertions, ordinarily the auditor considers:
(a) The assessment of the risk of material misstatement. Ordinarily, the auditor considers the understanding of the entity and its internal control, the materiality and likelihood of misstatement of the items involved, and the nature of the assertion in determining whether substantive analytical procedures are suitable. For example, if controls over sales order processing are weak, the auditor may place more reliance on tests of details rather than substantive analytical procedures for assertions related to receivables. As another example, when inventory balances are material, the auditor ordinarily does not rely only on substantive analytical procedures when performing audit procedures on the existence assertion. ASA 330 The Auditor’s Procedures in Response to Assessed Risks, indicates that when the approach to significant risks consists only of substantive procedures, the audit procedures appropriate to address such significant risks consist of tests of details only, or a combination of tests of details and substantive analytical procedures.
(b) Any tests of details directed toward the same assertion. Substantive analytical procedures may also be considered appropriate when tests of details are performed on the same assertion. For example, when auditing the collectibility of accounts receivable, the auditor may apply substantive analytical procedures to an ageing of customers’ accounts in addition to tests of details on subsequent cash receipts.
The Reliability of the Data
20 The reliability of data is influenced by its source and by its nature and is dependent on the circumstances under which it is obtained. In determining whether data is reliable for purposes of designing substantive analytical procedures, ordinarily the auditor considers:
(a) Source of the information available. For example, information is ordinarily more reliable when it is obtained from independent sources outside the entity.
(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 specialised 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.
(d) Controls over the preparation of the information. For example, controls over the preparation, review and maintenance of budgets.
21 Ordinarily, the auditor considers testing the controls, if any, over the entity’s preparation of information used by the auditor in applying substantive analytical procedures. When such controls are effective, the auditor has greater confidence in the reliability of the information and, therefore, in the results of substantive analytical procedures. The controls over non-financial information can often be tested in conjunction with other tests of controls. For example, an entity in establishing controls over the processing of sales invoices may include controls over the recording of unit sales. In these circumstances, the auditor could 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 in the current or prior period. In determining the audit procedures to apply to the information upon which the expectation for substantive analytical procedures is based, ordinarily the auditor considers the explanatory guidance in ASA 500 Audit Evidence.
Whether the Expectation is Sufficiently Precise
22 In assessing whether the expectation can be developed with sufficient precision to identify a material misstatement at the desired level of assurance, ordinarily the auditor considers factors such as:
The accuracy with which the expected results of substantive analytical procedures can be predicted. For example, the auditor will ordinarily expect greater consistency in comparing gross profit margins from one period to another than in comparing discretionary expenses, such as research or advertising.
The degree to which information can be disaggregated. For example, substantive analytical procedures may be more effective when applied to financial information on individual sections of an operation or to financial statements of components of a diversified entity, than when applied to the financial statements of the entity as a whole.
The availability of the information, both financial and non-financial. For example, the auditor considers whether financial information, such as budgets or forecasts, and non-financial information, such as the number of units produced or sold, is available to design substantive analytical procedures. If the information is available, the auditor also considers the reliability of the information as discussed in paragraphs 20 and 21 above.
Amount of Difference of Recorded Amounts from Expected Values that is Acceptable
23 In designing and performing substantive analytical procedures, ordinarily the auditor considers the amount of difference from expectation that can be accepted without further investigation. This consideration is influenced primarily by materiality and the consistency with the desired level of assurance. Determination of this amount involves considering the possibility that a combination of misstatements in the specific account balance, class of transactions, or disclosure could aggregate to an unacceptable amount. Ordinarily, the auditor increases the desired level of assurance as the risk of material misstatement increases by reducing the amount of difference from the expectation that can be accepted without further investigation. Paragraphs 27 and 28 below discuss the auditor’s response when the amount of difference between the expected value and the reported value exceeds the amount that can be accepted without further investigation.
24 When the auditor performs substantive procedures at an interim date and plans to perform substantive analytical procedures with respect to the intervening period, ordinarily the auditor considers how the matters discussed in paragraphs 18-23 affect the ability to obtain sufficient appropriate audit evidence for the remaining period. This ordinarily includes considering whether the period end balances of the particular classes of transactions or account balances are reasonably predictable with respect to amount, relative significance, and composition. See ASA 330 for additional explanatory guidance.