Audit analytical reviews are often associated with simple trend and variance analysis. There is no rocket science really. You only need to compare the current year’s performance to that of the prior year. As with any business, you’ll come across material and non-material fluctuations. And as all financial audits run on the basis of a materiality concept, you will most likely be required to document on the material fluctuations only.
Audit Managers/Audit Seniors are often baffled by these lines: “Administrative expenses have declined because utility expenses have decreased.” Well, guys, that is seriously not enough! Utility expenses represent a component of administrative expenses but here, you are expected to go an extra mile to explain “WHY”. Why did it decrease? Was a branch shut down? Or why did it rise instead? New offices were opened maybe; was there a leak; they worked overtime because of huge seasonal discounts or for a particular project? These answers will help you ‘understand the business’ as well.
Notwithstanding the professional guidance of business articles, audit firms’ methodologies and technical literature, I figured out a few elementary and practical documentation tips that can help an inexperienced auditor to make his way through this audit procedure.
Try to apply the acronym “WWWWWHR” or the “5W1HR”! Let us consider the example of a reduction in the sales account:
What really happened? In a few words, tell the story! Sales shrank by X% because a line product was removed from the market. Or it expanded because a high number of new products was introduced. Did the prices go up? Was there a new large customer base or seasonal bulk discounts?
Revenue is what drives the business. So ‘why’ would the company remove the product from the market? Is it a loss-making product and demands have gone down because of aggressive competition? Is the company downsizing? Or, on the more positive side, was it an aggressive attempt to acquire market share and become the industry leader?
Were sales price increases applicable throughout the whole financial year or only a few months near year-end? Was any large contract signed? On which date was that? It is important to know because this may have other financial impact and may require disclosures in the financial statements (e.g for other accounts related to disposal or acquisition of subsidiaries).
Either an external or an internal factor or, both, would have impacted the firm’s performance. One or more stakeholders can also affect a company. Was there a new policy, law, regulation imposed by the government? (Common examples that strike my mind here are tax laws and Employment Rights Act 2008). Did a competitor open its shop right next to your client’s? Customer preferences might have changed. Is there a new shareholder or a new business manager who has brought in new strategies and a new business model?
That is not so often applied but can be relevant in a few scenarios. Expenses might have increased because of relocation to a more expensive office/industrial area. Or the company is expanding overseas.
The board of directors or the company and the customer will most probably approve new contracts. Here, it is only about mentioning how the “what” or the “when” happened.
- Ratio analysis
Adding a ratio to your analytical review will surely improve the quality of your documentation. Mind you that you are not required to apply all financial ratios!! Simple ratios that you have learnt since college will do. The few most frequently analysed are simple decrease/increase %, gross profit margin, debtors collection period (in days), creditors repayment period (in days), stock turnover ratio, staff turnover ratio and the gearing ratio. Learn how to calculate these simple ratios if you don’t feel comfortable using them and always remember that numbers cannot speak for themselves. So, go back to the 5W1H to comment on your ratios! Feel free to add other financial ratios to your work.
All of the above will not apply in all circumstances or for all account balances or classes of transactions. Instead, one of these will most certainly apply for any financial audit. Even if all items apply, remember to summarize it in a couple of lines only. Within the limit of your professional walls, you are free to explore the documentation of your analytical reviews in other ways.
Happy International Accountant’s Day! 🙂
10 November 2016