When public accounting practitioners perform review engagements, evidence obtained through the performance of analytical procedures and inquiries generally provides the reasonable basis for obtaining the requisite limited assurance that the financial statements are in accordance with the applicable financial reporting framework.
Crucially, those analytical procedures and inquiries must be performed in a meaningful way and tied together. A practitioner should not perform analytics and inquiries in a perfunctory, routine or automatic manner. Using a “canned” approach can result in a substandard review engagement.
Analytical procedures and inquiries should be focused in those areas where the practitioner believes there are increased risks of misstatements. And they should be performed in concert with one another, not in isolation. The results of analytical procedures should affect and help shape the kinds of inquiries being asked, and the results of inquiries should affect the analytical procedures being performed.
Risk Awareness and Meaningful Review Procedures
Based on the practitioner’s risk awareness, review engagement procedures need to be tailored to address circumstances in which the heightened awareness indicates the potential for financial statements to be materially misstated.
Practitioners’ awareness of risk allows them to focus and tailor the analytical procedures and inquiries. To tailor review procedures appropriately, the procedures need to be focused on areas where practitioners believe there is an increased risk of material misstatement. Practitioners need to use professional judgment in determining the specific nature, timing and extent of review procedures.
In addition, if analytical procedures and inquiries are to be meaningful, practitioners should assess the results of those review procedures to determine whether their risk awareness related to the engagement should be modified and whether additional review procedures are necessary.
If analytical procedures or inquiries signal a red flag to a practitioner, or lead a practitioner to conclude that more evidence is required, then additional analytics and inquiries will need to be performed and procedures, outside analytics and inquiries might be needed for the practitioner to reach a comfort level of having obtained limited assurance.
Performing Meaningful Analytical Procedures
Analytical procedures are performed to ascertain whether there are relationships within and among the financial statements that appear unusual. Therefore, your practitioner’s understanding of the financial and nonfinancial relationships is essential in evaluating the results of analytical procedures and generally requires knowledge of your company and its industry.
Analytical procedures compare amounts or ratios developed from recorded amounts to expectations. When the comparison demonstrates unusual – or unexpected – results, the practitioner must investigate these results. They may require additional analysis or inquiry to understand why the associated accounts did not behave as expected.
Illustration: ABC Electronics sells new electrical equipment. The practitioner is performing a review engagement of ABC Electronics’ financial statements. As part of the analytical procedures, the practitioner develops a current ratio expectation for ABC Electronics of 0.6. The actual current ratio at year end is 0.9. The practitioner considers that difference to be significant and develops the following additional inquiries to ask management:
- Have any significant long-term assets been sold?
- Have current assets been acquired or short-term debt refinanced using long-term debt?
Analytical procedures cannot be performed appropriately without the practitioner developing expectations associated with the results of the procedures. Simply comparing recorded amounts in the current period with amounts from the prior period would not constitute the appropriate performance of analytical procedures unless it is concluded that current-period amounts are expected to be the same as prior-period amounts.
Performing Meaningful Inquiries
Inquiry is a fundamental technique used in a review engagement to collect evidence relevant to the financial statements. Inquiry procedures are most effective when the practitioner considers what questions to ask and pursues a significant line of questioning with appropriate professional skepticism.
Part of the practitioner’s duty is to remain appropriately skeptical when also considering responses. The quality of the review engagement is reduced dramatically if the practitioner performs inquiry in a perfunctory, automatic fashion and accepts responses from your company’s personnel without critical evaluation.
The review engagement does not contain a specific place where inquiry should begin or end. The effectiveness of the review engagement is improved when the practitioner remains inquisitive throughout the review engagement, raising appropriate questions and carefully evaluating the responses in the context of the specific engagement.
In addition, it is not possible to script the inquiries that should be made in a review engagement. Each engagement is unique, and each practitioner is unique. Nonetheless, effective inquiries are focused and relevant. – Bob Durak, CPA, CGMA, Director of AICPA Center for Plain English Accounting