A Wonder Drug for Auditors

Quality improves. In too many instances, today's auditors focus on detailed testwork without "taking a step back" to ensure that the numbers make sense. Oodles of audit failures have occurred because audit teams were "lost in the details."
Client service improves. Good analyticals require that an auditor have a solid understanding of the client's business. When this is true, the auditor is more capable of finding ways to help the client. Better management letters materialize. Value-added discussions are facilitated. The Financial Times wrote, "By adapting an analytical review approach, as opposed to a "tick and bash" approach, the auditor is forced to become conversant with the way the business works." Correctamundo.
Staff morale improves. Performing meaningful analyticals is far more interesting than footing, ticking, vouching, and confirming. Professionals at all levels will discover that their audit duties can be extremely interesting and rewarding. Be honest, now, how many individuals truly love to vouch? Hmmm?
Audit efficiency improves. Analyticals often involve less time than detailed testwork. Consequently, hours decrease even as the previously mentioned benefits are happening.

A Wonder Drug?
It sure sounds like analytical procedures are a wonder drug for the audit profession. Some of our readers, however, are probably skeptical. We don't blame you. The introduction of this article almost sounds like an infomercial, right? You've heard it before: "Take this herbal recipe and you'll grow hair, lose weight, make new friends, and have a better sex life. And it's only $29.99!"

But, there's a big difference, folks. Nobody is going to ask for your credit card number at the end of this article. Analyticals really can be a wonder drug for you audit department. Unfortunately, many audit shops refuse to take the medicine (or don't even know that the pills exist. You see, most analyticals done in the real world are weak. Unreliable. Unimaginative. Lame. This must change if the benefits described above are to materialize.

The Efficient Auditor is determined to help change this sad state of affairs. Since a minimal amount of practical guidance is available on good analyticals, The Efficient Auditor is here to show real-world examples rather than intellectual, theory-laden, psychobabble gobbledygook (any typos, there?). All rightie, then, let's begin.

How to Do Better Analyticals
Some auditors are uncomfortable with the idea of replacing detailed testwork with analytical tests. This is because they are most familiar with "weak" analyticals that don't provide much evidence. Well, their response should not be to continue doing tons of detailed testwork. Instead, their response should be to make analyticals stronger so that a reduction in detailed testing is justifiable.

How do you make an analytical procedure stronger? Two major ways:

Make it more precise
Obtain corroborating evidence

It's that simple folks. Oh, you want some examples? Good.

Sample Analytical Comments

Accrued Commissions

12/31/97 12/31/96 % change Accrued Commissions 129,101 100,004 29% V V Accrued Commissions increased due to an increase in sales.

Weak. This analytical needs to be more precise. Exactly how much did sales go up? But even that's not enough. Are sales Commissions paid on all sales, or just certain types? When does the company pay commissions to salespersons?

12/31/97 12/31/96 % change Accrued Commissions 129,101 100,004 29% V V Commissions are paid to salespeople on a monthly basis. Thus accrued commissions should relate to December sales. 12/97 sales were 25% higher than previous year. Further, commissions range from 4-6%. December sales were 2.5 million. 129/2,500=5.2%. Balance appears reasonable.

Better. Note how this auditor made the analytical more precise. She actually proves that the account balance makes sense using two quick approaches: a comparison to the prior year and a reasonableness test based on this December's sales.

Sales

                      c/y           p/y         % change

Sales                 33,542,323    28,433,390   18%  **

          



**  Per discussion with Laurie (the Controller), sales are 

    up due to a strong economy under the leadership of Bill  

    Clinton.

Weak. The auditor is clearly in the "write down what the client says" mode since the political commentary is a personal opinion. Further, this explanation could be much better by interviewing someone outside of the accounting department.

                      c/y           p/y         % change

Sales                 33,542,323    28,433,390   18%  **

          



**  Per discussion with Reginald K. Dwight, Sales Manager,

    sales increased primarily due to the success of a new

    product, a Glow-in-the-Dark Football. Its sales went 

    from 1.2 to 5.1 mil in the past year (see L-5 for

    clippings from newspapers and trade publications). 

    Otherwise, sales increased a modest 4.3% which was 

    in line with budget.

Better. Notice how the auditor frees himself from the accounting department by talking to the Sales manager. He also includes documented evidence (clippings) to corroborate the client's explanations. By isolating the new product sales, the auditor makes the analytical more precise and is also able to conclude that the 15% increase is reasonable.

Gross Salaries

                      c/y           p/y         % change

Gross Salaries        2,986,055     2,879,513   3.7%  ##

          



##  Based upon comparison to prior year, change in payroll

    is reasonable as it is consistent with prior year.

Weak. Many auditors incorrect assume that since current and prior year numbers are comparable, then everything must be okay. Trial balance software exacerbates this problem since it easily spits out variances that exceed certain parameters (e.g., greater than $100,000 and 10 percent). Generally accepted auditing standards require than an auditor form an expectation about the account balance. A comparison to the prior year can be useful, but it can also be irrelevant.

                      c/y           p/y         % change

Gross Salaries        2,986,055     2,879,513   3.7%  ##

          



##  Per ADP report, number of employees was 75 as compared

    to 74 last year. Companywide raises were 3-4 percent per 

    board minutes. Increase appears reasonable.

Better. This auditor did not assume that payroll should be comparable. Instead, he figured out the company's two biggest variables that impact gross salaries: headcount and pay raises. Rather than simply asking someone in the accounting department about these factors, he gathered evidence from credible sources (ADP report and board minutes) before concluding that payroll expense was fairly stated.

Prepaid Fuel

                        12/31/97     12/31/96     

Prepaid Fuel            258,222      279,493       F-2.1

Weak. The cross-reference to F-2.1 to a workpaper where lots of ticking, tieing, footing, and cross-footing was done.

                        12/31/97     12/31/96     

Prepaid Fuel            258,222      279,493        AA



AA  The client owns 6 boats that contain fuel at y/e. At

    12/31/96, there were 9 boats, but 3 were sold in 1997. 

    Also per Thurston Howell, Dir. Of Operations, one boat 

    was dry docked at year-end. Thus, we expected to see a   

    major decline in prepaid fuel. Upon inquiry with the

    Controller, we discovered that an 84k adjustment was

    needed.

Better. This auditor addresses the balance analytically before diving into the details. Based on knowledge of what is happening in the company, the auditor quickly figures out that the prepaid balance is overstated. He instructed the client to investigate and a major adjustment was identified. Who knows if the "weak" auditor would have even caught the error, even though he spent more time.

Note
Even the "better" analyticals could be stronger, of course. How? Make them more precise. Obtain better corroborating evidence. And here's the key point: the stronger your analytical, the greater justification that you have for reducing other substantive procedures.