Substantive Analytical Procedures Research Articles

External Nonfinancial Measures in Substantive Analytical Procedures: Contributions of Weather Information

ABSTRACT Recent studies and new standards suggest that auditors can use information from expanded external sources to verify their clients’ financial information. We propose advanced substantive analytical procedures with external nonfinancial measures derived from weather information to test whether it helps detect misstatements. Using computational simulations and daily store-level sales data, we test whether the proposed procedures with weather indicators outperform the procedures without such indicators in substantive analytical procedures to identify overstated daily store sales. For the multilocation retail firm examined in this study, we find that the models with one or more weather indicators perform better at detecting misstatements than the models without them. When the reliability of relevant internal information is in question, the usefulness of weather indicators is apparent. Overall, our results provide evidence suggesting the potential value of external nonfinancial measures in auditing.

DEVELOPING A MEASUREMENT INSTRUMENT FOR TECHNICAL AND ANALYTICAL SKILLS IN AUDITING FOR ENHANCED FRAUD DETECTION

This study bridges a significant gap in forensic accounting and fraud detection by establishing a standardized measure for Technical and Analytical Skills (TAS) in external auditing. Despite the acknowledged importance of TAS in fraud detection, the absence of a universally accepted definition and measurement instrument has limited the field's advancement. This research introduces a validated TAS measurement instrument, underpinned by a novel framework that categorizes TAS into six critical dimensions: Substantive Analytical Procedures, Technical Tools and Software, Critical Thinking, Innovation and Solution Implementation, Professional Development, and Quantitative and Statistical Analysis. A structured survey among 360 auditors from international firms in Southern Africa confirmed the instrument's reliability, with Cronbach's alpha values exceeding 0.70 across all dimensions, and supported the distinctiveness of the six-factor structure through confirmatory factor analysis. The instrument's potential to enhance auditing practices and fraud detection capabilities is considerable. It offers a foundation for future research to explore its cross-cultural applicability, predictive validity, and adaptation to technological advancements. This contribution not only provides a robust tool for auditing professionals but also fosters a culture of innovation and continuous learning within the field.
 Keywords:  Technical and Analytical Skills, Forensic Accounting, Fraud Detection, External Auditing, Skill Measurement, Professional Development, Confirmatory Factor Analysis, Auditing Education.

Application of Linear Regression Models in Substantive Analytical Procedures for Auditing Asset Management

Application of Linear Regression Models in Substantive Analytical Procedures for Auditing Asset Management

Can Substantive Analytical Procedures with Data and Data Analytics Replace Sampling as Tests of Details?

ABSTRACTTo avoid problems caused by moderate or weak substantive analytical procedures (SAPs), audit firms tend to focus more on tests of details than SAPs, especially for large income statement accounts such as revenues. Based on findings from previous studies, this commentary study attempts to: (1) summarize the outcomes of SAPs developed by advanced analytics models (e.g., regression and time-series models), and (2) respond to the question of SAP use by evaluating the limitations and benefits if one test replaces the other. The outcomes of prior studies generally show that SAPs developed by advanced analytical models do not provide a high level of assurance for revenue. Since SAPs and audit sampling present different risks and unique benefits, they are often complementary. Without the careful consideration of conditions related to the risks and benefits of each test, simply avoiding SAPs could reduce the effectiveness of substantive tests.

The Reel Wheel: Using Analytical Procedures as Substantive Tests of Account Balances

ABSTRACT This case provides students an introductory experience to substantive analytical procedures in a realistic audit setting. Students are presented with a scenario, adapted from a real-world example, requiring them to (1) research relevant auditing standards, (2) develop an independent expectation for a client's revenue account, and (3) consider the precision of the estimate, additional audit procedures, and the reliability of the underlying data and evidence obtained. In completing the case, students will learn to: (1) explain the benefits and challenges of using substantive analytical procedures, (2) research relevant auditing standards, (3) create and analyze relevant substantive analytics, (4) evaluate the appropriateness of data aggregation in substantive analytical procedures, and (5) discuss factors affecting the reliability of data used by the auditor. The case is typically assigned as an out-of-class assignment, combined with a subsequent in-class discussion. It can be used in either undergraduate or graduate auditing courses.

Disclosure and Audit Implications of Nonfinancial Measures: A Teaching Case

SUMMARY This case introduces students to nonfinancial measures (NFMs) and encourages thoughtful consideration and discourse surrounding their reporting and use by managers and auditors. NFMs are commonly reported by companies to provide increased transparency of operations and to more effectively describe performance. External parties such as analysts and auditors make use of NFMs in performing valuation assessments, fraud risk assessments, and substantive analytical procedures. In completing this case, students will be exposed to actual NFMs disclosed in SEC filings and employ Microsoft Excel knowledge to perform foundational analytical procedures. Students will also analyze how these NFMs link to the financial statements, as well as reflect upon the implications of NFMs for both internal and external users.

IMPORTANCE OF REASONABLENESS TESTS AND RECOMMENDATIONS FOR ITS APPLICATIONS

Objective- Analytical procedures have higher potential compared to test of details in terms of analysing the account relationships, detecting significant risk of misstatement, reducing audit fieldwork and testing management assertions. In order to get benefit of those procedures, auditors should access more entity specific resources and invest more time in planning the audit program. In this study, reasonableness tests that are generally used in substantive analytical procedures are analysed through industry examples and their role in reducing the audit risk is demonstrated. Methodology- In this study, case study method is used as a research methodology. The reason of selecting this methodology is due to its relevance in accordance with the objective of the study as well as providing an opportunity to auditors that would like to implement reasonableness tests. Findings - This study reveals, through examples that can be used in practice, that the management claims can be tested more soundly through rationality tests when more time is given to the stages of understanding the enterprise and planning the audit. Conclusion- Among the analytical review techniques, reasonableness test is highly effective technique for testing the relationship between non-financial information and financial information. In order to use the reasonableness tests more frequently in the evidence collection, understanding the enterprise, more senior and industry specific team construction and accessing the non-financial information by inquiring also the performance indicators used by the enterprise are important. Agreements for longer than a year between the auditor and the company will reinforce the auditor's accumulated knowledge on the enterprise that will increase number of reasonableness tests.

Between a Rock and a Hard Place: A Path Forward for Using Substantive Analytical Procedures in Auditing Large P&L Accounts: Commentary and Analysis

SUMMARYSubstantive analytical procedures can be an important and effective audit tool to gather evidence and highlight areas of potential misstatement, and for decades have been one of the common substantive procedures applied to income statement accounts. Recently, however, there is a growing trend for public company auditors to forego substantive analytical procedures on large income statement accounts, such as revenue, due to criticisms from regulatory inspectors that such procedures are not capable of providing useful substantive evidence. In this commentary, we address the concern that discouraging the application of appropriately rigorous substantive analytical procedures may diminish overall audit quality. We consider whether rigorous substantive analytical procedures can be designed to provide useful evidence at moderate and low levels of assurance for large income statement accounts, such as revenue, even when the significant-difference threshold exceeds overall materiality. Such procedures can provide strong evidence that financial statements are free of massive fraud or unintentional misstatement. Further, the moderate or low assurance obtained by such substantive analytical procedures can be combined with assurance provided by other audit procedures to yield high overall assurance. We illustrate one potential approach that may be useful in designing substantive analytical procedures to achieve moderate or low assurance and we explain how our approach is consistent with auditing theory and auditing standards.

Between a Rock and a Hard Place: A Path Forward for Using Substantive Analytical Procedures in Auditing Large P&L Accounts: Commentary and Analysis

Substantive analytical procedures can be an important and effective audit tool to gather evidence and highlight areas of potential misstatement, and for decades have been one of the common substantive procedures applied to income statement accounts. Recently, however, there is a growing trend for public company auditors to forego substantive analytical procedures on large income statement accounts, such as revenue, due to criticisms from regulatory inspectors that such procedures are not capable of providing useful substantive evidence. In this commentary, we address the concern that discouraging the application of appropriately rigorous substantive analytical procedures may diminish overall audit quality. We consider whether rigorous substantive analytical procedures can be designed to provide useful evidence at moderate and low levels of assurance for large income statement accounts, such as revenue, even when the significant-difference threshold exceeds overall materiality. Such procedures can provide strong evidence that financial statements are free of massive fraud or unintentional misstatement. Further, the moderate or low assurance obtained by such substantive analytical procedures can be combined with assurance provided by other audit procedures to yield high overall assurance. We illustrate one potential approach that may be useful in designing substantive analytical procedures to achieve moderate or low assurance and we explain how our approach is consistent with auditing theory and auditing standards.

Causal Inference in Auditing: A Framework

SUMMARYCausal inference—that is, determining the “root cause(s)” of an observed anomaly—is one of the most fundamental audit tasks. This study develops an analytical framework to formally model conditions present in many audit settings, and provides illustrations related to performing substantive analytical procedures. We examine four conditions not fully considered in prior research: multiple hypotheses about what may cause an anomaly, multiple items of evidence with varying diagnosticity, observed effects that may not be certain, and hypotheses sets that may not be exhaustive. The results reveal when the following phenomena should occur: (1) discounting or inflating of posterior probabilities, (2) superadditive probabilities of various causes, and (3) unchanged probability of a potential cause given evidence in support of a different cause. The analytical findings have implications for the design and interpretation of experimental auditing research, for educating novice auditors, and for potentially improving audit practice.

Shoe Zoo, Inc.: A Practice in Electronic Work Papers, Tick Mark Preparation, and Client Communication through the Audit of Property, Plant, and Equipment

ABSTRACT In this case, students are required to audit a company's gross property, plant, and equipment and depreciation expense accounts. Students are provided with electronic working papers that include the audit program, as well as documents prepared by the client and select prior year working papers. In order to successfully complete the audit, students will have to obtain explanations and other assistance from the client. The case furthers audit education by illuminating to students how concepts learned in the classroom translate into practice. The case has several specific learning objectives. First, the case familiarizes students with electronic working papers which allows them to practice their Excel skills. Second, the case provides students with an opportunity to audit property, plant, and equipment additions using substantive details testing and to test depreciation expense using substantive analytical procedures. Third, students must consider internal controls and the implications errors have on internal control effectiveness. Fourth, the case helps students improve documentation skills by writing tick mark explanations. Finally, the case provides students practice with professional verbal communications through client interviews. The case is appropriate for an undergraduate audit or a beginning graduate-level audit and assurance class.

Trade-offs in audit testing

Abstract This case is designed to help you to understand one of the fundamental concepts underlying audits of financial statements: the impact of testing controls on the substantive audit testing to be conducted. When determining the nature, timing and extent of substantive testing, the auditor must consider the costs involved in testing controls and compare that cost to the savings in substantive testing that can occur by relying on the tested controls. In other words, the auditor trades off control testing and substantive testing to determine the best mix of procedures. Similarly, for substantive evidence, the auditor must determine the best mix of substantive analytical procedures and tests of details. In this case, you will assess the trade-offs between the various types of auditing procedures (tests of controls, substantive analytical procedures and tests of details) to determine the optimal audit strategy.

Does Auditing Deter Potentially Fraudulent Earnings Management? An Experimental Investigation

Effective audits are claimed to not only enhance the detection of fraud but also the deterrence of fraud in the first place. To focus on whether auditing has a deterrence effect separate from the detection effect, we design an experiment that isolates the deterrence effect from the detection effect. The experiment with 96 senior corporate managers features changes in audit procedures that would increase the likelihood of fraud being detected in the other divisions of the company but not in the focal manager’s division. Indeed, audit attention is reduced in the focal manager’s division due to a planned rotation in audit procedures that results in less substantive tests of details and more substantive analytical procedures in the focal manager’s division. We find that focal managers commit less potentially fraudulent earnings management in their own division when the nature of evidence collected changes towards increased probative value in the other managers’ divisions, but not when there is an increase in the extent of evidence collected employing the same audit tests. We also find that changing the nature of audit evidence collected results in more of a reduction in potentially fraudulent earnings management than the increased extent of audit evidence does, due to the auditor being perceived as more unpredictable under evidence nature changes than evidence extent changes. Overall our findings demonstrate that auditing has deterrence effects separate from an audit’s detection effects and that enhancements in deterrence are associated with the increased unpredictability of the audit procedures.

Auditors' Assessment and Incorporation of Expectation Precision in Evidential Analytical Procedures

This paper reports on an experiment that investigates auditors' abilities to assess expectation precision and incorporate their assessments into judgments related to substantive analytical procedures, as required by professional standards. Auditors appear sensitive to both account predictability and level of information detail in assessing expectation precision overall; however, their assessments do not reflect differences in level of detail when the account is less predictable. This finding supports regulators' and prior researchers' calls for additional guidance to assist auditors in forming expectations that consider the nature of the account. We also find that auditors judge the level of assurance from analytical procedures consistent with their precision assessments. However, in contrast to guidance specified in professional standards, we find that auditors do not always incorporate their precision assessments into judgments about the range of possible differences between expected and recorded amounts, nor the likelihood of misstatement causes. Failing to do so may lead auditors to make important decision errors.

DISCUSSION OF Why Do Auditors Over-Rely on Weak Analytical Procedures? The Role of Outcome and Precision

INTRODUCTION Years after the AICPA wrote the audit guide on analytical procedures (APs) to improve the effectiveness of APs in practice (AICPA 1998), regulators continue to express concerns about auditors’ improper and deficient applications of substantive APs (PCAOB 2004; POB 2000). Glover, Prawitt, and Wilks (2005) (hereafter, GPW), not only contribute to a long line of research that addresses auditors’ effectiveness in applying APs, but also notably add to the sparsely researched area on APs used as substantive tests. This line of research is relevant for practice because, with increasing frequency, auditors are using substantive APs (Ameen and Strawser 1994; Asare and Wright 2001), yet APs used inappropriately have contributed to several accounting debacles including, in part, the WorldCom fraud (see Hitzig 2004). In this paper, GPW specifically address one reason why substantive APs may be ineffective (i.e., auditors’ improper assessment of AP design strength) and examine a possible cause (i.e., auditors’ sensitivity to outcome). The sensitivity to outcome is consistent with research related to the influence on auditors’ judgments of prior-year book values (e.g., McDaniel and Kinney 1995) and outcomes in planning AP (Lin et al. 2000), but heretofore has not been documented in a substantive AP application. In addition, because the assessment of AP strength (i.e., precision) is central to effective application and interpretation of APs, this research addresses a relevant practice issue and provides incremental evidence needed to address regulators’ calls for ways to improve auditors’ use of substantive APs. GPW ask whether a ‘‘favorable’’ outcome from a substantive AP (i.e., when the difference between the expected and book values is not significant) influences the extent to which auditors believe they can rely on the procedure. GPW predict that auditors seeing a favorable (i.e., no difference) outcome will over-rely on a weak procedure (i.e., one in which the auditor’s expectation is developed from relatively aggregated data). They also ask a second question: Will the requirement to evaluate the strength of the AP prior to evaluating its outcome reduce auditors’ over-reliance on weak APs?

Why Do Auditors Over-Rely on Weak Analytical Procedures? The Role of Outcome and Precision

Recent evidence from highly publicized frauds and from the Public Oversight Board's Panel on Audit Effectiveness (2000) indicates that auditors sometimes over-rely on evidence provided by weak substantive analytical procedures. In Experiment 1 we examine whether auditors' assessments of evidence quality are affected by a “favorable outcome” bias, manifested when an analytical procedure indicates that the balance under examination is fairly stated. In Experiment 2 we examine whether an explicit ex ante prompt can activate knowledge that will sensitize auditors to the weaknesses of an unreliable substantive analytical procedure. The first experiment provides evidence that auditors attribute more strength to a weak, aggregate-level analytical procedure that produces an expectation that is not significantly different from the unaudited numbers (i.e., a “favorable” outcome), than to the same analytical procedure that produces an expectation that is significantly different from the unaudited numbers. Further, auditors in the “favorable outcome” condition adjust their initial assessments down to a level very similar to that of auditors in the “unfavorable outcome” condition after seeing a more precise analytical procedure, while auditors in the unfavorable outcome condition do not change from their initial assessment after seeing the more precise procedure. Taken together, our results suggest that when a low-quality analytical procedure yields no significant difference, auditors tend to overestimate the strength of the evidence provided. Results from the second experiment indicate that the explicit consideration of potential weaknesses associated with the highly aggregated analytical procedure reduces auditors' assessments of the strength of evidence obtained from the aggregate procedure. Subjects' explanations suggest that the prompt activated their knowledge of the factors contributing to the quality of the analytical procedure.

The Effect of Accountability and Time Budgets on Auditors' Testing Strategies*

AbstractThis study investigates the joint effects of accountability and time budgets on auditors' testing strategies. The task studied, substantive analytical procedures, requires auditors to identify and test hypotheses when investigating the cause of unexpected fluctuations. Thus, auditors must determine the number of tests to conduct (i.e., extent), the number of potential hypotheses to directly test (i.e., breadth), the number of tests for each hypothesis (i.e., depth) and the number of potential error or non‐error hypotheses to test (i.e., focus). Testing strategies, which we define as choices made with respect to extent, focus, depth, and breadth of testing, have significant practical and theoretical implications. For example, reducing the breadth of testing may result in failure to test the correct hypothesis, potentially impairing audit effectiveness.In this study, auditors inherited five potential causes of an unexpected increase in the gross margin of a client. As in practice, their task was to conduct tests to investigate and identify the actual cause of the fluctuation. Auditors were randomly assigned to one of four conditions created by fully crossing accountability and time budgets. The results indicate that accountability leads to an increase in the extent and breadth of testing but does not affect the depth of testing. Further, accountability leads to an increase in the testing of errors but results in a decrease in the testing of non‐errors. The focus on breadth and error testing is consistent with the notion that accountability, to a superior with unspecified preferences, promotes more cautious behavior. The results also show that a time budget decreases the extent and depth of testing but does not affect the breadth of testing. There was no evidence that the two factors interactively affected testing strategies or performance. Finally, increased breadth of testing was the mechanism that led to better performance as measured by the identification of the actual cause of the unexpected fluctuation.