When Judgment Counts

Implications for improving analytical procedures practices.

    • ANALYTICAL PROCEDURES can improve audit efficiency and effectiveness, yet these procedures require significant audit judgment on the part of the auditor in identifying and investigating unexpected fluctuations.
    • STATEMENT ON AUDITING STANDARDS no. 56, Analytical Procedures, characterizes the steps to be used in these procedures.
    • RESEARCH STUDIES found auditors were prone to various judgment errors that could seriously impair the value of analytical procedures.
    • AUDITORS SHOULD NOT consider managements unaudited balances as a starting point in the audit process.
    • AUDITORS HAVE TO investigate causes of fluctuations and look for patterns rather than consider each account individually.
    • AUDITORS SHOULD COME UP with potential explanations for fluctuations based on their knowledge of the company and industry before going to management.
    • POTENTIAL EXPLANATIONS NEED TO be tested and carefully evaluated to ensure they fully explain the fluctuations present.
TIMOTHY B. BELL, CPA, is director of assurance services at KPMG Peat Marwick, Montvale, New Jersey. He is president-elect of the American Accounting Association auditing section.
ARNOLD M. WRIGHT, CPA, is Arthur Andersen Professor of Accounting at Boston College, Chestnut Hill, Massachusetts. He is a past president of the AAA auditing section.

C PA firms continue to compete for audit clients and therefore need to offer them value-added services. One way they can improve the efficiency and effectiveness of audits is by expanding the use of analytical procedures in all phases of the audit. However, research indicates that when auditors perform analytical procedures they face potentially serious judgment problems. This article elaborates on the nature of these problems and discusses how research has helped identify ways to avoid them.

Some of the most important problems include:

What Are Analytical Procedures?
"Analytical procedures involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor." —Statement on Auditing Standards no. 56, Analytical Procedures

  • Allowing unaudited account balances (or ratios) to unduly influence expectations of what current balances should be.

  • Not fully considering the pattern reflected by several unusual fluctuations when trying to explain what caused them.

  • Placing reliance on managements explanations about unusual fluctuations without first fully developing independent explanations.


Statement on Auditing Standards no. 56, Analytical Procedures , characterizes analytical procedures in terms of three steps:

  1. Developing expectations of the account balances or the ratios.

  2. Identifying unusual or significant departures from expectations.

  3. Investigating departures from expectations to determine whether fluctuations are due to changes in business conditions or to material misstatements in the financial statements.

Research showed that auditors were prone to considering managements unaudited balances as a starting point in the audit process. Relying on current unaudited balances, however, may bias an auditor when deciding whether to further investigate and may possibly adversely affect audit efficiency or effectiveness (see exhibit 1). For instance, if business, client or economic conditions had changed from the prior year, an auditor relying on stable unaudited balances or ratios (indicating "no change") might inappropriately conclude there were no unexpected fluctuations and thus miss identifying a material error. There should have been changes. Remember also that a client may attempt to bias financial statements to create the desired "stable growth" trend that investors and creditors look for, producing the pattern of "no change" noted.

Audit testing should involve corroboration of account balances by comparing unaudited balances with independent expectations of what those balances should be. For example, in detailed testing using sampling, an auditor should have an independent expectation of an account balance formed from selecting a sample of transactions affecting the balance; validating the selected sample items using independent information about their accuracy, existence, valuation and so on; and inferring a population balance using the audited amount derived from the sample. The auditor should then compare the expected population balance with the reported unaudited balance and accept or reject the difference, depending on judgment about materiality. If the auditor allowed the unaudited amounts for the sample items to influence the expected population balance (by ignoring detected errors in the sample, for example), inferences about the population balance would be suspect. This is also true when using analytical procedures for audit testing. That is, the audit test would be unreliable if the expectation of an account balance or ratio was unduly influenced by unaudited amounts.

Research suggests current unaudited balances can unduly influence auditors expectations; as a result, the American Institute of CPAs auditing standards board included specific wording about the auditors responsibility to develop independent expectations and to use reliable data when developing such expectations. For example, the highlighted quotation from SAS no. 56 specifically says " developed by the auditor ." [Emphasis added.]

For More Information

The practice implications discussed in this article are drawn from research studies reported in a chapter, "Analytical Procedures," in a 1995 AICPA publication Auditing Practice, Research, and Education: A Productive Collaboration, edited by Timothy B. Bell and Arnold M. Wright. The chapter was written by Stanley F. Biggs, University of Connecticut; W. Robert Knechel, University of Florida; Norman R. Walker, Price Waterhouse; Wanda A. Wallace, College of William and Mary (chapter lead author); and John J. Willingham, University of Texas at Austin.

This publication (product no. 010290JA; $25 for members, $27 for nonmembers) documents important findings from auditing research that emerged early in the 1900s and flourished over the past 20 years. The following topics are addressed:

  • The continuing evolution of the audit approach from a procedural to a risk-driven orientation.

  • Auditor decision making and its influence on auditing practice, including the development of decision tools.

  • Audit sampling.

  • Analytical procedures.

  • The changing scope of CPA communications with users.


Once an auditor has identified an unexpected fluctuation, he or she has a responsibility to determine its cause, whether it is an error (misstatement in the financial statements) requiring adjustment or a non-error (change in business conditions). When investigating fluctuations, the auditor should consider their likely causes and then test to determine the plausibility of those causes. If the auditor cannot identify a correct cause at this point, it is unlikely the cause will be detected later. It is important that the auditor consider all the likely causes, particularly in using analytical procedures as a substantive form of evidence.

Research shows that failure to recognize a pattern of fluctuations (see exhibit 2) can greatly impair an auditors ability to identify the correct cause of a fluctuation. This can happen because

  1. Auditors may evaluate the financial discrepancies one account at a time rather than evaluate combinations of financial discrepancies; without using a pattern of critical cues, they cannot identify the error.

  2. Even if they recognize the pattern of critical cues, auditors may be unable to generate a correct explanation about the underlying cause of the discrepancies.

Research findings identified a final potential problem when investigating unexpected fluctuations involving consultation with client management. When they encounter fluctuations, auditors often go to management for an explanation. This can substantially impair audit efficiency or effectiveness. A plausible but incorrect client explanation can lead to unnecessary, costly procedures in testing the explanation. Further, given the highly competitive auditing environment, a time budget may prevent the auditor from fully exploring other explanations, resulting in an improper conclusion.


This article discusses research findings that identify several important implications for practice in applying judgment when auditors conduct analytical procedures.

  1. Auditors should be careful not to let unaudited account balances or account balance interrelationships unduly influence their development of expectations for these amounts. When using an analytical procedure (especially as a substantive test), the auditor should develop expectations on an independent basis using reliable data.

  2. Auditors can be more effective in identifying errors by examining patterns of discrepancies. They can make significant judgment errors if they perform analytical procedures by separately considering discrepancies in each individual account.

  3. Auditors should independently identify plausible explanations for unexpected material fluctuations from their knowledge of the client and industry before going to client management. A clients explanation poses the risk of limiting the auditors ability to consider other likely causes, thus leading to unnecessary, costly procedures in testing a management explanation that is not the most feasible one. Auditors should exercise professional skepticism by independently developing possible explanations about causes of fluctuations before consulting with management.

  4. Auditors must fully evaluate the explanations generated about possible causes for unexpected fluctuations. Many auditors who select an incorrect explanation can easily disconfirm it if they consider whether the explanation adequately accounts for the discrepancies identified. To this end, an auditor should consider how the explanation (debits and credits) affects the account balances. The auditor may then evaluate a proposed audit adjustment to see whether it eliminates the fluctuations present or, instead, results in discrepancies in other accounts or does not account for the magnitude of the fluctuation.

Analytical procedures offer great promise for significantly improving audit efficiency and effectiveness. However, application is more art than science. In the end, the auditor must avoid common judgment pitfalls. Recognition of these common pitfalls—and safeguards against them—is essential for appropriate use of analytical procedures.

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