Risk is the major concept of an audit. Auditors strive to determine the operational and financial risks exposed to an organization. Use of analytic audit helps in determining whether an organization would be in business several years after its audit. Analytic audit increases the efficiency of the audit. Analytic procedures comprise of evaluations of the financial data and the relationship between financial and non-financial data. Analytic procedures vary from simple comparisons such as comparing the financial data and non-financial data of the current year and the previous year or the use of complex method to determine the relationships between various elements of the financial or non-financial data. Regression analysis is one of the complex methods used to determine the financial position of a company (Rittenberg, Johnstone & Gramling, 2011).
The foundation for the use of analytical procedures is that there is a relationship between data. In addition, the relationships are expected to continue in the absence of certain conditions that are known to change the relationship. Unusual transactions or events, business or accounting changes, and random fluctuations are some of the factors that may lead to changes in the relationship between the data (Gupta, 2004).
The aim of analytic procedures during the audit planning phase is to act as an attention-directing tool. Auditors use analytical devices to determine the type, nature, and extent of the substantive procedures of the audit process. Use of analytical procedures during this phase helps in improving the auditor’s understanding of the audit risks that the company faces. This is due to the fact that the company may have unusual or unexpected balances or relationship between various data (Gupta, 2004).
Some of the analytical procedures used by auditors include account balance comparison, calculation of significant ratios, calculation of various ratios using non-financial and financial data, and regression analysis. Account balance comparison involves the comparison of unadjusted trial balance and the adjusted balance of the previous year. This helps in showing the liquidity of the company. The auditor may also calculate various financial ratios. Calculation of the financial ratios determines the current financial position of the company. The auditor should compare the financial ratios with the financial ratios of the previous years. This would show a trend in the ratios, which would be critical in determining whether the company would be in business several years after the audit. The auditor may also calculate various ratios using non-financial data. For example, the auditor may calculate the sales of the company per square foot of sales floor space. If the results of the audit show that there may be errors, the auditor is given more time to test the results to determine their validity (Rittenberg, Johnstone & Gramling, 2011).
Various financial ratios are vital in determining whether a company would be in business several years after the audit. The ratios of public companies include working capital/total assets, earnings before interest and taxes/ total assets, and sales/ total assets. Calculation of the ratios would help in determining certain coefficients. If the coefficients are below a certain level, it may be an indication that a company has a high risk of facing impending bankruptcy within one or two years. Development of computer technology has enabled audits to use regression models as one of the analytical procedures. Regression models are the most effective analytical procedures for auditors (Rittenberg, Johnstone & Gramling, 2011).