Designing and investigating analytical procedures in a review

• Perform the four analytical procedures required by AR-C 90
• Develop an expectation and an acceptable difference under AR-C 90
• Investigate significant differences through inquiry and other procedures
• Document analytics so an experienced accountant can follow them

Why analytics carry the review

AR-C 90.04 describes a review as primarily analytical procedures and inquiries. AR-C 90.25 requires those procedures to address all material items, including disclosures, and the areas where you believe risk of material misstatement is increased. Analytics identify what to ask about; inquiry explains it.

AR-C 90 defines analytical procedures as evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data, including investigation of fluctuations that are inconsistent with other information or differ from expected values by a significant amount.

The four required comparisons

AR-C 90 requires analytical procedures that include:

1. comparing the statements with comparable prior-period information, considering known changes in the business and specific transactions
2. considering plausible relationships among financial and, when relevant, nonfinancial information
3. comparing recorded amounts or ratios to expectations you develop from relationships you reasonably expect to exist, based on your understanding of the entity and its industry
4. comparing disaggregated revenue data, as applicable

The application material gives an example of the fourth: revenue by month and product line or segment compared with prior periods. It gives examples of the second: gross margin percentages, and payroll cost against number of employees.

A flux schedule that lists this year, last year and the dollar change satisfies only the first item. The third requires you to say what the number should be before you look at it.

Building the expectation and threshold

AR-C 90 requires you to:

• determine whether a particular procedure is suitable
• consider the reliability of the data used to build the expectation (source, comparability, nature and relevance)
• develop an expectation and evaluate whether it is precise enough to give limited assurance that a misstatement which could be material, alone or aggregated, would be identified
• determine the difference from expectation that is acceptable without further investigation, then compare

The application material accepts that review expectations may be less precise than audit expectations. Precision still matters: an expectation of "about the same as last year" will not catch much. Build from drivers: headcount and pay rates for payroll, average debt and rate for interest, unit volume and price for revenue. The analytical procedures workpaper has columns for expectation, basis, threshold and explanation.

Set the acceptable difference below materiality from the materiality lesson. A threshold at or above materiality makes the procedure useless.

Investigating differences

AR-C 90 requires you to investigate fluctuations or relationships that are inconsistent with other information or differ from expectations by a significant amount by inquiring of management and performing other review procedures if needed. AR-C 90 says you consider whether responses are reasonable and consistent with other results and your knowledge of the business, but you are not required to corroborate them. The application material adds that other procedures may be needed when management cannot explain a difference or the explanation is not adequate.

If the investigation causes you to believe the statements may be materially misstated, AR-C 90 requires additional procedures sufficient to conclude either way. That might mean vouching a sample of December sales, reading a contract, or recomputing an accrual.

Documentation and common findings

AR-C 90 requires documentation that lets an experienced accountant with no previous connection understand the nature, timing and extent of procedures, the evidence and conclusions. For analytics, that means the expectation, its basis, the threshold, the result, who explained the difference, and why the explanation is reasonable.

Peer review findings in this area:

• prior-year comparisons only, with no expectations and no disaggregated revenue
• explanations that restate the change ("revenue increased because sales increased")
• no threshold, or a threshold above materiality
• disclosures not addressed even though AR-C 90.25 covers them

The flux analysis calculator speeds up the arithmetic; the judgment stays in the explanation column.

A payroll expectation at Lakeview Physical Therapy, LLC