RIAM:VLA:ANALYTIC REVIEW PROCEDURES IN INTERNAL AUDIT
- 1 PHASE 1 to 3: ANALYTIC REVIEW PROCEDURES
- 1.1 Definition
- 1.2 Objectives of Analytic Review Procedures
- 1.3 Considerations before using Analytic Review Procedures
- 1.4 When Can ARP Be Used
- 1.5 ARP Techniques
- 1.6 Financial Systems ARPs
- 1.7 Non-Financial Techniques/Performance Indicators
- 1.8 Relative Costs - ARP, Compliance & Substantive Tests
- 1.9 Other Quantitative Techniques (Operations Research)
- 1.10 Backlinks
PHASE 1 to 3: ANALYTIC REVIEW PROCEDURES
Analytic Review Procedures (ARP) are used to analyse significant ratios and trends including the resulting investigations of unusual fluctuations and items. It is the study and evaluation of relationships among measurable financial and performance information. ARP are used on the assumption that relationships exist and that variances in these relationships can both provide audit evidence and point to the need to collect further evidence. It is a form of testing which and audit evidence which is generally rapid to assemble, but relies on the integrity of the underlying data.
Non-financial application of ARP revolves arround the analysis of management performance indicators such as demand, output, efficiency, effectiveness and environmental indicators.
Examples of non-financial applications of ARP include; a change in demand with no change in staffing level, increase in percentage of complaints, and client surveys indicating timeliness problems.
Objectives of Analytic Review Procedures
The objectives of ARP include:
- identification of potential risk areas that will require focussed audit attention;
- providing evidence in relation to established audit assertions to vary the nature timing and extent of audit tests; and
- performing reasonableness tests to satisfy audit assertions
Considerations before using Analytic Review Procedures
- . The objectives ARP intend to achieve and the degree of assurance that can be obtained from it.
- . The type of organisation under consideration and the relevance of ARP.
- . Available industry ratios and their comparability to that of the organisation.
- . Volatility within the organisation and industry and its effects on ARP.
- . The relevance and reliability of in-house information and data in utilising ARP.
Availability of performance measurement data and the precision of the performance indicators in measuring identifiable variables.
When Can ARP Be Used
ARP can be used at three stages. These are:
- . at the planning stage;
- . at the systems evaluation and data analysis stage; and
- . at the reporting stage.
ARP at the planning stage
- by increasing the understanding of the organisation's operations;
- by highlighting potential risk areas which may require increased attention; and
- with planning the nature, extent and timing of audit procedures to verify the established assertions.
ARP at the systems evaluation and data analysis stage
- with confirming the hypotheses reached at the planning stage;
- by identifying changes, if any, from the planning stage encouraging us to revise the nature, extent and timing of audit procedures if necessary; and
- verifying the validity of the established assertions.
ARP at the reporting stage
- justifying or explaining conclusions reached at the systems evaluation and data analysis stage; and
- confirming conclusions reached.
Nature of ARP
This varies largely depending on individual audit circumstances. ARP includes comparison of financial information with:
- comparable information for prior periods, for example, a reduction in stock turnover but increase in stock costs, therefore less efficient buying quantities;
- anticipated results, for example comparing actual results with budgeted results and investigating variances; and
- similar industry information, for example, comparing floor plan interest between car dealers of different sized entity's, and average staff to floor space ratio.
ARP also includes the study of relationships:
- among elements of financial information, for example gross profit percentages;
- between financial information, for example, wages to number of employees;
- between various performance indicators such as demand to output indicators; and
- between operating periods.
Various techniques are available for use by auditors ranging from simple techniques to more complex analyses both for financial systems and non-financial systems. These include:
|AR TECHNIQUE||NATURE OF PROCEDURE|
|Common form statements||Evaluative|
|Time Series Analysis||Predictive|
|Time Series Modelling||Predictive|
|Non-financial Techniques/Performance Indicators|
|Key Result Area Appraisal||Evaluative|
|Staff Utilisation and Productivity||Evaluative|
The above list is not exhaustive but suffices for the scope of this course. We will now briefly explain some of the above AR techniques.
In the foregoing table we classified the techniques as either evaluative or predicitive. The distinction is not particularly important, but it serves to highlight that ARP can focus on both describing the present and anticipating the future.
Financial Systems ARPs
This is comparison of current year item to a norm, for example:
- a current year item to that of a prior year
- a current year item to budgeted figures.
Delta analysis measures the difference between the two figure as a percentage of the independent variable. In the examples above the independent variable would be the prior year results and the budget respectively.
Common Form Statements (CFS)
CFS are statements that express balance sheet components as a percentage of some figure such as total assets and profit and loss components as a percentage of total revenues, assuming the entities have comparable operating structures.
This facilitates analysis by comparison of entities, such as departments, companies or even divisions of different sizes.
CFS are particularly powerful where the key figures in an entity's financial statements are dependent on external factors such as sales. Here we wish to preserve a profit margin therefore varying expenses in time with sales.
This compares reasonableness of account balances in relation to some other account balance or some non-financial base.
Some examples include;
- interest expense to borrowings
- depreciation charge to fixed assets
- wages to employee number
- dividend income to investments
This is similar to common form statements in that all numbers are expressed as a percentage of a base. Each number in the trend statement is expressed as a percentage of its own level in a selected base year. Percentage analysis focuses on trend changes rather than the absolute magnitude of dollar changes. Such an analysis may also be applied to physical units, production hours, as well as dollar units.
Trend analysis should be evaluated by the auditor using knowledge of the client's business as to whether past trends are expected to continue into the current period, or whether changes are expected.
Ratio analysis is an expression of the relationship between relevant financial information items. Ratios may be compared with benchmarks established using internal or external data.
Some of the more prominent ratios include stock turnover, debtors turnover, gross profit percentage (for revenue collection activities).
Non-Financial Techniques/Performance Indicators
The purposes of these reviews include:
- whether objectives of the programs are being achieved;
- whether the functions of the functions of the programs are conducted effectively and efficiently;
- the overall soundness of procedures and systems;
- the overall soundness of management practices and procedures;
- the adequacy of internal controls;
- whether staffing structure is appropriate for the program objectives ;
- cost effectiveness of procedures;
- efficiency and adequacy of EDP\information technology facilities; and
- whether the overall policies and guidelines of DOF and the Auditor-General for the program are being followed.
Types of Non-Financial Techniques/Performance Indicators include:
- Key Result Area Appraisal
- Effectiveness Indicators
- Output Indicators
- Client Surveys
- Demand Indicators
- Efficiency Indicators
- Environment Indicators
Relative Costs - ARP, Compliance & Substantive Tests
The internal audit function is no different to any other area of the department in that it has to make best use of the resources made available to it. For this reason, in devising and carrying out the test program it is important to be aware of the costs associated with various types of tests and the need to minimise the more costly approaches.
Analytical review is generally the least expensive of the audit tests available as it involves no sampling and uses already available management information.
Compliance tests, which involve testing the key control points in the controls analysis for compliance with the intended system (ie are the forms authorised as required, etc) are generally the next least expensive because they provide for the "proving" of figures and balances. If the system design is accepted during systems analysis, the compliance test establishes reliance on the operation of the system that produces the figures rather than requiring the proving of the individual figure or balance. In addition, compliance testing allows for an assessment of the degree of statutory and managerial compliance with required procedures and practices which is much more difficult under other testing methods.
Substantive tests of transactions are the most expensive tests because recalculations and tracings to source documentation and statistically significant financially based samples are required. When combined tests of transactions are done, the compliance part of the tests are usually less costly. (In some literature ARP are treated as a form of substantive test.)
Other Quantitative Techniques (Operations Research)
Techniques related to ARP, that are quantitative in nature and of potential use to Internal Auditors include:
- Expected Value
- Bayseian Analysis (Decision Trees or Payoff Tables)
- Regression Analysis and Curve Fitting
- Linear Programming
- Project Scheduling and Network Models
- PERT Network Model
- Queuing Theory