Test of Detail Vs Analytical Procedures
Test of detail is the audit procedure used to collect the audit evidence to evaluate the financial assertion of the accounts. The form of test of detail will be changed depending on the nature of accounts and the financial assertion that auditor wants to achieve.
Auditing Standard does not provide a clear definition of the test of detail, however, we can have a basic understanding by looking at the example and explanation below.
Example of Test of Detail
Test of detail include the following example:
- Vouching: Auditor may perform tests of detail by vouching for the supporting documents of expense, revenue, and other accounts. It is one the most common form of test of detail. It helps auditors to test financial assertion such as occurrence, accuracy, cut-off, existing, and classification.
- Search for unrecorded liabilities: This test of detail is specifically used for accounts payable or other liabilities as the name suggests. Auditors believe that the company may try to understate the liability balance. So they simply focus on the cut-off testing if the accounts payable balances are recorded in the new accounting period rather than the prior one. This testing can achieve two assertions: cut-off and completeness of liabilities.
- Test bank reconciliation: Again, this testing is to test the cash at the bank. Auditor simply compares the bank statement and company ledger and finds the reconciling items.
- Send Confirmation: The auditor can get more reliable information by acquiring confirmation from third parties. We can send confirmation to confirm bank balance, Accounts payables, accounts receivable, and donor fund (for NGO).
- Reconciliation: Auditors need to reconcile Fixed Asset listing, Inventory listing, Accounts Payable listing, Accounts receivable listing, and so on. Auditors want to ensure that these listings are the same as the trial balance or other reports. It is very important to do the reconciliation before using it to perform another testing.
Analytical Procedures are the procedure the auditor use to evaluate the financial information by comparing both financial and non-financial data and analyze their relationship. Auditors use the relevant financial information to compare if they are correlated and follow the historical trend. In a simple word, they want to check if the financial statements are reasonable or not, that why this procedure also the reasonableness test. Auditors build their own expectations and compare the information with their expectations. If the information is different from the expectation, they have to find and validate the explanation. If the explanation is invalided, there will be an indicator of misstatement which requires further testing.
Example of Analytical Procedures
- Ratio analysis: Auditor can compare current ratio to the previous year’s ratio. The ratio should be consistent with the prior years or industry average unless the company has a significant change. The current ratio should be similar to the previous year as the balance of current assets and current liabilities. The current asset and current liabilities cannot grow multiple times if the business remains the same. Similar expectations also happen to the other ratios as well.
- The trend of bad debt expense: Bad debt expense of the company should be consistent with the prior year unless there is something change with the customer base.
- Salary Expense: Without significant expansion, the salary expense should be increased similar to the annual increment.
- Depreciation Expense: Annual depreciation expense should be the same if the company does not purchase or dispose of significant assets.
Process of Analytical Procedure
The analytical procedure should follow these step:
- Develop Independ Expectation: It is the auditor’s expectation after understand client business and industry. For example, auditors expect the revenue and expense remain the same from last year as the company does not invest in any new product, location, or segment. We expect the payroll to increase around 5% due to annual increment as we expect the number of staffs to remain the same.
- Define Threshold: Not all variances require investigation, so auditors need to define the acceptable level of variance. It is the level which we can accept without further investigation. It related to the overall audit risk and the risk at the account level.
- Compute the difference: We have to compare our independent expectation and the actual number and define the variance. In most cases, there is always variance.
- Investigate and Conclusion: Auditor will investigate the variance which is higher than the threshold. Auditors need to find the reasons and use professional judgment to evaluate them. It depends on knowledge and experience to draw the conclusion from the investigation.
Auditor can make conclusions based on their evaluation of the variance. The variance may be raised to the overlook when developing independent expectations. If so, the auditor needs to evaluate the process again.
However, the difference may be the indication of material misstatement in the account.
If the auditor not satisfies, a further substantive test will be preform to draw a conclusion.