Sharpe CPA / For CPAs / Analytic review
Comparing this year to last year is not an analytical procedure. An expectation is. This guide covers what the standards require in reviews and audits, how to build expectations precise enough to catch a material misstatement, a worksheet that does the arithmetic, and the ratios that matter for fuel distributors and contractors.
What is required
In both, the accountant judges whether the procedure suits the account, considers how reliable the data is, develops an expectation precise enough to reveal a material misstatement, sets the difference that needs no further work, and then compares. A review cannot be performed without analytical procedures; in an audit they are required at planning and at the end, and may be used as substantive procedures.
| Review (AR-C 90) | Audit (AU-C 315, 520) | |
|---|---|---|
| Where | Every material item, including disclosures, and every area of increased risk (.25) | Planning, as a risk assessment procedure (315.14b); as substantive procedures where chosen (520.05); near the end, for an overall conclusion (520.06) |
| Required comparisons | Prior period, adjusted for known changes; plausible financial and nonfinancial relationships; expectations from knowledge of the entity and industry; disaggregated revenue (.26) | Chosen to address the assessed risks and assertions (520.05a) |
| Designing the procedure | Suitability; reliability of the data; an expectation precise enough for limited assurance; the acceptable difference set before comparing (.27) | The same, with precision enough to identify a misstatement that could be material, alone or with tests of details (520.05) |
| Differences | Inquire of management; perform other procedures if needed. Corroboration is not required, but responses must be reasonable and consistent with what else is known (.28, .30) | Inquire and obtain evidence for management's responses; other procedures as needed (520.07) |
| Documentation | Enough for an experienced accountant to follow the work: the expectation and its basis, the comparison, inquiries, responses and the accountant's judgment of them (.137) | The expectation and factors, the comparison, and the investigation and its results (520.08) |
Paragraph numbers are from the current AICPA codifications. AR-C 90.26–.28 were paragraphs .19–.21 in SSARS No. 21 as issued.
The process
The AICPA's practice aid for review engagements describes analytic review as four phases. Almost every weak analytic fails in phase 1: the expectation was last year's number, so any misstatement that looked like a normal change went straight through.
Precision
Precision is how close the expectation is likely to be to the right answer. The closer it is, the more likely a difference means a misstatement rather than noise. Four things drive it: the method, how disaggregated the data is, how reliable the data is, and how predictable the account is.
| Method | What it is | Precision | Use it for |
|---|---|---|---|
| Trend | This year against last year or several years | Lowest, and biased toward accepting the recorded amount | Stable, small accounts; only after adjusting for known changes |
| Ratio | Relationships between accounts, or to nonfinancial data or industry figures | Low to moderate; evaluate the dollar effect, not the change in the ratio | Receivable days, inventory days, gross margin, expense to sales |
| Reasonableness test | An explicit prediction from drivers: volume × rate, headcount × pay, debt × interest rate | Moderate to high | Payroll, interest, depreciation, rent, fuel gross profit, excise tax, commissions |
| Regression | A statistical model of the balance from several predictors | Highest, and measurable | Large, data-rich revenue and cost accounts, mostly in audits |
Tools
Pick a reasonableness test, enter the drivers, and send the result to the worksheet. The threshold helper uses the firm's default, the lower of 10 percent of the expectation and half of materiality. That is firm guidance, not a standard: set your own if the risk calls for it.
Lower the threshold for areas of increased risk. A threshold above materiality cannot catch a material misstatement.
Worksheet
One line for each account or relationship. Differences over the threshold need an explanation and the amount it explains; the unexplained remainder is the possible misstatement. Entries stay in this browser only; export to CSV for the file.
| Account or relationship | Method | Recorded | Expected | Threshold | Difference | Status | Explanation | Explained | Unexplained |
|---|
Ratio library
Ratios find accounts that have moved out of line; evaluate what they find in dollars, not in the change in the ratio.
| Ratio or test | How | What a change can mean |
|---|
Explanations
Management's answer is not the end of the analytic. It has to be plausible, consistent with everything else you know, and large enough to account for the difference. Quantify it; whatever it does not explain is a possible misstatement.
| Weak | Strong |
|---|---|
| “Sales were up.” | “Diesel gallons rose 9 percent with the new Colusa contract (contract and terminal volumes seen); at the average margin that adds $61,000 of the $70,000 difference.” |
| “Timing.” | “A $48,000 load billed January 3 was delivered December 30 and recorded in December; bill of lading seen.” |
| “Prices went up.” | “Average rack price rose 11 cents (published rack data); on 1.9 million gallons that is $209,000 of the $230,000 increase.” |
| “We had a lot of repairs.” | “Two tank-wagon engines replaced, $38,000 (invoices seen); considered whether they should be capitalized.” |
Sharpe CPA portal subscribers record the same work on the Analytical procedures workpaper inside each review plan.
Sources
The standards control. The practice aid is nonauthoritative guidance. Thresholds, warning signs and examples on this page are the firm's own and are illustrative.