5 PAGES RESEARCH
Advances in Accounting Education: Teaching and
Curriculum Innovations
Analytical Procedures: An In-Class Exercise
Chris Bagwell, Linda A. Quick, Scott D. Vandervelde,
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http://dx.doi.org/10.1108/S1085-462220170000020004
ANALYTICAL PROCEDURES:
AN IN-CLASS EXERCISE
Chris Bagwell, Linda A. Quick and
Scott D. Vandervelde
ABSTRACT
We have designed this in-class exercise to benefit undergraduate or grad-
uate students enrolled in courses in auditing. This in-class exercise
involves six short independent analytical procedures scenarios, two each
for three different accounts: Payroll Expense; Depreciation Expense;
and Interest Expense. The scenarios require students to perform substan-
tive analytical procedures for each of the financial statement accounts.
Students must use their accounting knowledge, analytical thinking skills,
and problem-solving ability in order to compute an estimated expectation
for an account balance. Following computing an estimate of the expected
balance, students must then compare the result to the client-recorded
balance and determine if the difference is within tolerable limits
Advances in Accounting Education: Teaching and Curriculum Innovations, Volume 20, 51�78
Copyright r 2017 by Emerald Publishing Limited
All rights of reproduction in any form reserved
ISSN: 1085-4622/doi:10.1108/S1085-462220170000020004
51
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http://dx.doi.org/10.1108/S1085-462220170000020004
established for the audit. The primary learning objectives for the in-class
analytical procedures exercise involve the following:
1. Understanding when it might be appropriate for the auditor to
perform substantive analytical procedures,
2. Understanding how to form an expectation of an account balance
when performing analytical procedures, and
3. Understanding how to evaluate the results of a substantive analytical
procedure.
In cooperation with KPMG, we believe that the analytical procedures
exercise gives students a better understanding of performing substantive
analytical procedures.1 As identified by Auditing Standard AU-C 520,
PCAOB Standard AS 2305, and in the academic literature (e.g., Hirst
& Koonce, 1996), analytical procedures are an important part of the
audit process. Understanding when and how to perform substantive
analytical procedures, combined with how to evaluate the results, will aid
in student knowledge of the audit process.
Keywords: Analytical procedures; substantive testing; undergraduate
auditing
While analytical procedures have been part of a financial statement audit
for decades (e.g., PCAOB AS 2305, effective for audits of financial state-
ments for periods beginning on or after January 1, 1989), Public Company
Accounting Oversight Board inspections from 2004 to 2007 revealed that
auditors need to improve the performance of analytical procedures
(PCAOB, 2008). In the report, the board stated:
Inspection teams have identified deficiencies in firms’ performance of analytical proce-
dures that the firms intended to be substantive tests, including the failure to (a) develop
appropriate expectations, including in some instances the failure to appropriately dis-
aggregate data in order to obtain the necessary level of precision for the expectation,
(b) establish a threshold for differences that the firm could accept without further inves-
tigation, (c) establish a threshold for differences that was low enough to provide
the level of assurance that the firm planned to achieve from the test, (d) test the data
that the firm used in the analytical procedures, (e) investigate significant unexpected
differences from the firm’s expectations, and (f) examine other evidence to obtain cor-
roboration of management’s explanations regarding significant unexpected differences.
(PCAOB, 2008, p. 15)
52 CHRIS BAGWELL ET AL.
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As indicated by the inspection report, auditors make errors when perform-
ing analytical procedures, thus highlighting the need for continued learning
at all levels.
The importance of performing substantive analytical procedures is
highlighted in the recent guidance in AU-C 520 (AICPA, 2012; effective for
audits of financial statements for periods ending on or after December 15,
2012). AU-C 520.05 provides steps the auditor is to take when performing
analytical procedures either in conjunction with other substantive proce-
dures or as substantive procedures.2 The analytical procedures the students
perform during this in-class exercise are consistent with what is proscribed
in the standard.
A significant amount of accounting research has been performed related
to analytical procedures.3 In a field study, Hirst and Koonce (1996) find
that the techniques being used in practice to estimate balances when per-
forming substantive analytical procedures are regularly used and they are
used to decrease other substantive testing which is more time-consuming
(Trompeter & Wright, 2010). Additionally, analytical procedures are fre-
quently being performed by lower level staff auditors (Trompeter &
Wright, 2010). Moreno, Bhattacharjee, and Brandon (2007) found that stu-
dents who were trained in certain ways performed as well as practicing
auditors on analytical procedure tasks. One of those training methods was
using “worked-out examples.” Therefore, substantive analytical procedure
techniques are important for students to learn, in order to increase the like-
lihood of performing high quality audit procedures.
This in-class exercise involves six short independent analytical proce-
dures scenarios, two each for three different accounts: Payroll Expense;
Depreciation Expense; and Interest Expense. The scenarios require students
to perform substantive analytical procedures for each of these financial
statement accounts. Students must use their accounting knowledge, analyti-
cal thinking skills, and problem-solving ability in order to compute an esti-
mated expectation for an account balance. After computing an estimate of
the expected balance, students must then compare the result to the client-
recorded balance and determine if the difference is within tolerable limits
established for the audit. While these scenarios have been very effective for
the authors as an in-class exercise, instructors could also assign any or all
of them as out-of-class work; however, some of the benefit of the in-class
exercise is having practicing auditors act as facilitators during the class
period. The original scenarios were designed for KPMG firm-wide training,
thus having KPMG personnel facilitating provides valuable insight for the
students in addition to providing further opportunity for students to
53Analytical Procedures: An In-Class Exercise
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interact with professionals and continue to refine interpersonal communica-
tion skills. The KPMG personnel also add credibility to the use of analyti-
cal procedures that is not always achieved by just being covered by
accounting faculty.
LEARNING OBJECTIVES AND IMPLEMENTATION
GUIDANCE
While we have experienced great success in using these scenarios during
class with a KPMG professional leading the discussion, instructors can use
these scenarios without any assistance from a representative from the pro-
fession. KPMG representatives (including one of the co-authors on this
chapter) have been coming to our Audit 1 class for eight years to partici-
pate in the in-class learning case scenarios presented in this chapter.
Students have regularly responded very favorably to this exercise and
greatly appreciate the involvement of representatives from the profession
(typically alumni from the participating school) during the class period in
leading the exercise discussion. Having accounting firm professionals
involved increases the credibility of the procedures from the student’s per-
spective. Although professional communication skills are not one of the ini-
tial primary objectives, it also continues to help them develop these skills
by interacting with professionals. Even without assistance from a represen-
tative from the profession in class, the nature of the scenarios lends them-
selves to active discussion, thus enhancing professional communication
skills of the students. KPMG personnel originally created the case scenar-
ios for in-house training related to analytical procedures.
Learning Objectives
The primary learning objectives for the in-class exercise involve the following:
1. Understanding when it might be appropriate for the auditor to perform
substantive analytical procedures,
2. Understanding how to form an expectation of an account balance when
performing analytical procedures, and
3. Understanding how to evaluate the results of a substantive analytical
procedure.
54 CHRIS BAGWELL ET AL.
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Understanding When to Perform Substantive Analytical Procedures
AU-C 520.05 identifies when to perform substantive analytical procedures
and the general approach to performing such procedures:
When designing and performing analytical procedures, either alone or in combination
with tests of details, as substantive procedures in accordance with section 330, the audi-
tor should (Ref: par. A7-.A9)
a. Determine the suitability of particular substantive analytical procedures for given
assertions, taking into account the assessed risks of material misstatement and tests
of details, if any, for these assertions; (Ref: par. A10-.A16)
b. Evaluate the reliability of data from which the auditor’s expectation of recorded
amounts or ratios is developed, taking into account the source, comparability, and
nature and relevance of information available and controls over preparation; (Ref:
par. A17-.A20)
As seen in the exercise, we incorporated some of this information into the
exercise in the “required” section for the task and in telling the students the
criteria that have been met which leads to the substantive analytical proce-
dures being performed over the given accounts. Additionally, there are
PowerPoint slides that the KPMG personnel used at the beginning of the
class period to discuss when substantive analytical procedures might be
appropriate to be performed in lieu of or in conjunction with test of details
as a substantive procedure.4
Understanding How to Form an Expectation of an Account Balance When
Performing Analytical Procedures
The authoritative guidance on “how” to form an expectation for an
account balance starts with the definition of an analytical procedure in stat-
ing the following (AU-C 520.04)5
.04 For the purposes of generally accepted auditing standards, the following term has
the meaning attributed as follows:
Analytical procedures. Evaluations of financial information through analysis of plausi-
ble relationships among both financial and nonfinancial data. Analytical procedures
also encompass such investigation, as is necessary, of identified fluctuations or relation-
ships that are inconsistent with other relevant information or that differ from expected
values by a significant amount. (Ref: par. A2-. A6)
Understanding How to Evaluate the Results of a Substantive
Analytical Procedure
a. Develop an expectation of recorded amounts or ratios and evaluate whether the
expectation is sufficiently precise (taking into account whether substantive
55Analytical Procedures: An In-Class Exercise
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analytical procedures are to be performed alone or in combination with tests of
details) to identify a misstatement that, individually or when aggregated with other
misstatements, may cause the financial statements to be materially misstated; and
(Ref: par. A21-.A23)
b. Determine the amount of any difference of recorded amounts from expected values
that is acceptable without further investigation as required by paragraph .07 and
compare the recorded amounts, or ratios developed from recorded amounts, with
the expectations. (Ref: par. A24)
When evaluating the results of substantive analytical procedures, the audi-
tor must complete the following decision process:
.07 If analytical procedures performed in accordance with this section identify fluctua-
tions or relationships that are inconsistent with other relevant information or that differ
from expected values by a significant amount, the auditor should investigate such differ-
ences by
a. inquiring of management and obtaining appropriate audit evidence relevant to
management’s responses and
b. performing other audit procedures as necessary in the circumstances. (Ref: par.
A28-.A29) (AU-C 520.07)
Implementation
In collaboration with KPMG, we have always had audit personnel from
the local KPMG office lead the discussion of the analytical procedures in-
class exercises with our Audit 1 class.6 Typically there is at least one audi-
tor at the manager level or above supported by one or two senior or staff
level auditors.7 The first part of class is designed for the KPMG
representative(s) to utilize the PowerPoint presentation to guide a discus-
sion in a predominantly lecture format about the use of analytical proce-
dures, including the important role that they play, how to perform
substantive analytical procedures, and the implications of the results.8
Following the slides covering substantive analytical procedures, the
remainder of the time is spent working on the exercise scenarios. The exer-
cise includes background information and instructions along with six short
scenarios that require students to conduct analytical procedures on one of
three financial statement accounts. Table 1 includes the background infor-
mation and instructions that we distribute to the students. The instructions
note that the student is acting as the auditor for a US-based client; the
accounts in question are considered low risk, and thus substantive analyti-
cal procedures are considered sufficient evidence; and the precision level for
56 CHRIS BAGWELL ET AL.
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Table 1. Background and Instructions.
Background
You are the auditor of a United States client. You are entering the preliminary testing
phase of the audit work program which instructs you to perform substantive analytical
procedures in order to perform substantive test work over some previously identified low
risk financial statement accounts. The internal controls testing surrounding these accounts
have not uncovered any deficiencies that would preclude a lower control risk being included
in the auditor’s risk assessment for the accounts. The financial statement accounts for
which you are going to perform substantive analytical procedures meet all of the following
criteria:
1. The transactions within the account are routine and the results are reasonably predictable,
2. The transactions within the account do not involve complex accounting standards or
complex judgments by management, and
3. There are relationships among data that exist and continue in the absence of known
conditions to the contrary.a
Given the low levels of risk of material misstatement surrounding these accounts, it has
been indicated to you that performing a substantive analytical procedure over the accounts
will provide sufficient appropriate audit evidence in order to conclude on the account
balances and respective assertions. For the purposes of this exercise, it is assumed that the
data you have received that will be used to form your expectations of the account has been
separately subjected to sufficient appropriate audit procedures and is therefore reliable for
use in the substantive analytical procedure to be performed. Following the determination of
your expectation for the account balance, you are to compare any difference between what
you calculate and the client-recorded account balance. It has been determined that the level
of precision to be used in this comparison is ±5% of the expected balance that you
calculate. If any difference between the expected balance and the recorded balance is within
the ±5% precision, then no further investigation will be necessary. If the difference is
greater than the ±5% precision level, then additional investigation will be necessary for an
audit team in practice. For this exercise, you should consider the types of additional
testing, but you will not be asked to actually perform it as it is beyond the scope of this
activity. You will need to determine how the expected balance was calculated, what might
have led to the difference, and what (if any) additional substantive testing might be
necessary.
Instruction
Use the information provided in the exercise scenarios for each of the accounts to determine
an expectation for the current year balance for each of the following scenarios. Compare the
expected balance you calculate to the client-recorded balance. Conclude on whether the
difference is within the ±5% level of precision and think about the implications of your
findings for the audit. You should consider each scenario as independent of the other
scenarios.
aThese criteria are consistent with AU-C 520.5 and 520.A8.
57Analytical Procedures: An In-Class Exercise
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the analytical procedures is ±5% of the expected balance. The KPMG
representative(s) first goes through a very brief introduction of each sce-
nario. While each of the scenarios could be completed individually or in
groups, we have always used groups of 3�5 students. We assign each group
one of the scenarios and give them time to compute an expected value of
the assigned account balance using the facts provided in each scenario.
During this time the KPMG personnel (and professor) walk around and
help groups as needed. We provide the solutions for all of the scenarios to
the students following class for them to be able to review each scenario
that was not assigned to their group. However, another option is to include
the rest of the scenarios as an out-of-class assignment and provide the solu-
tions at some later date.
The first two scenarios, shown in Table 2 and Table 3 (with
corresponding solutions in Table 4 and Table 5, respectively), test payroll
expense. We provide information regarding the number of workers per
store, the number of new and existing stores, the average wage per hour,
the regular and overtime hours worked, and the prior year’s payroll
expense. Students can calculate the number of hours worked based on the
number of employees per store, the number of stores existing at the begin-
ning of the year, and the number of stores opened during the current year.
In Scenario 1, the client opened all new stores on October 1. In Scenario 2,
the client opened new stores evenly throughout the year.
The third and fourth scenarios, shown in Table 6 and Table 7 (with cor-
responding solutions in Table 8 and Table 9, respectively), test depreciation
expense. We provide information regarding asset categories and the cost
basis, accumulated depreciation, and expected life for each category, along
with new assets purchased in the current year and service dates for all assets
(new and old). The primary difference between Scenario 3 and Scenario 4,
besides the acquisition date for new assets, is that in Scenario 4, we note
that the company’s policy is to begin depreciating the assets at the begin-
ning of the quarter after they are put in service. Because this is a non-
GAAP policy, we expect students to ignore this policy when calculating
their expected depreciation expense.
The final two scenarios, shown in Table 10 and Table 11 (with corre-
sponding solutions in Table 12 and Table 13, respectively), test interest
expense. We provide information regarding balances and terms (including
interest rates) for outstanding debt, as well as the amount outstanding at
the beginning of the year and amounts paid on the debt throughout the
year. Scenario 5 includes three bonds with various interest rates and terms.
Scenario 6 includes three bonds with various interest rates and terms, as
58 CHRIS BAGWELL ET AL.
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Table 2. Analytical Procedure Scenario 1.
Payroll Testing 1
ABC Restaurant Company
Payroll Testing Fact Sheet
December 31, 2016
ABC Restaurant Company owned 133 stores in 2015. Each store employs 32 hourly
employees on average and each employee worked approximately 8 hours of overtime per
week. In 2015, we performed tests of details over hourly payroll expense. The procedures
performed in 2015 included selecting a statistical sample of 134 employees. For each employee
we recalculate five weekly paychecks. To accomplish this, we obtained five different weekly
timecards for each employee, recalculated payroll expense for each employee, and traced that
amount to the weekly payroll summary report. Then, each weekly payroll report was traced to
the general ledger.
In 2016, we would like to determine a more efficient method to test payroll expense for hourly
employees. Below are a summary of facts that were obtained from the 2015 audit workpapers:
1. Employees in 2015 = 4,250
2. Average wage per hour = $14.50
3. Average employee hours per week = 48
4. 2015 regular hourly payroll expense = $128,180,000
5. 2015 overtime hourly payroll expense = $38,454,000
6. 2015 total payroll expense = $166,634,000
Below are a summary of facts obtained from inquiries of the corporate controller and the
payroll manager related to the 2016 audit of payroll expense:
1. 43 new stores were obtained on October 1.
2. Each store employs 32 hourly workers.
3. Overtime pays time and a half.
4. Management implemented a strategy that reduces overtime by 50% per employee compared
to 2015.
5. There were no raises for hourly employees.
6. Assume each employee works 40 regular hours per week.
7. Assume 52 weeks per year.
8. 2016 client-recorded payroll expense = $161,253,989.
59Analytical Procedures: An In-Class Exercise
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Table 3. Analytical Procedure Scenario 2.
Payroll Testing 2
DEF Restaurant Company
Payroll Testing Fact Sheet
December 31, 2016
DEF Restaurant Company owned 133 stores in 2015. Each store employs 32 hourly
employees on average and each employee worked approximately 8 hours of overtime per
week. In 2015, we performed tests of details over hourly payroll expense. The procedures
performed in 2015 included selecting a statistical sample of 134 employees. For each employee
we recalculate 5 weekly paychecks. To accomplish this, we obtained five different weekly
timecards for each employee, recalculated payroll expense for each employee, and traced that
amount to the weekly payroll summary report. Then, each weekly payroll report was traced to
the general ledger.
In 2016, we would like to determine a more efficient method to test payroll expense for hourly
employees. Below are a summary of facts that were obtained from the 2015 audit work papers:
1. Employees in 2015 = 4,250
2. Average wage per hour = $14.50
3. Average employee hours per week = 48
4. 2015 regular hourly payroll expense = $128,180,000
5. 2015 overtime hourly payroll expense = $38,454,000
6. 2015 total payroll expense = $166,634,000
Below are a summary of facts obtained from inquiries of the corporate controller and the
payroll manager related to the 2016 audit of payroll expense:
1. 43 new stores were obtained evenly throughout the year.
2. Each store employs 32 hourly workers.
3. Overtime pays time and a half.
4. Management implemented a strategy that reduces overtime by 50% per employee compared
to 2015.
5. There were no raises for hourly employees.
6. Assume each employee works 40 regular hours per week.
7. Assume 52 weeks per year.
8. 2016 client-recorded payroll expense = $170,125,987.
60 CHRIS BAGWELL ET AL.
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Table 4. Analytical Procedure Scenario 1 Suggested Solution.
Payroll Testing 1
ANSWER
Average wage per hour 14.5 A
Overtime hours per employee 4 B
2015 employees 4,250 C
Regular hours (existing employees) 8,840,000 D = C*40*52
OT hours (existing employees) 884,000 E = C*B*52
New employees 1,376 F = 43*32
Regular hours (new employees) 715,520 G = F*40*52*.25
OT hours (new employees) 71,552 H = F*B*52*.25
2016 regular payroll � existing employees 128,180,000 = D*A
2016 regular payroll � new employees 10,375,040 = G*A
2016 OT payroll � existing employees 19,227,000 =E*A*1.5
2016 OT payroll � new employees 1,556,256 =H*A*1.5
Total expected payroll 159,338,296
Actual payroll expense 161,253,989
Difference (1,915,693)
% difference �1.20%
Test result PASS
Table 5. Analytical Procedure Scenario 2 Suggested Solution.
Payroll Testing 2
ANSWER
Average wage per hour 14.5 A
Overtime hours per employee 4 B
2015 employees 4,250 C
Regular hours (existing employees) 8,840,000 D = C*40*52
OT hours (existing employees) 884,000 E = C*B*52
New employees 1,376 F = 43*32
Regular hours (employees) 1,431,040 G = F*40*52*.5
OT hours (existing employees) 143,104 H = F*B*52*.5
2016 regular payroll � existing employees 128,180,000 = D*A
2016 regular payroll � new employees 20,750,080 = G*A
2016 OT payroll � existing employees 19,227,000 = E*A*1.5
2016 OT payroll � new employees 3,112,512 = H*A*1.5
Total expected payroll 171,269,592
Actual payroll expense 170,125,987
Difference 1,143,605
% difference 0.67%
Test result PASS
61Analytical Procedures: An In-Class Exercise
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Table 6. Analytical Procedure Scenario 3.
Depreciation Expense 1
GHI Restaurant Company
Depreciation Expense Fact Sheet
December 31, 2016
Below are a summary of facts obtained from inquiries of the corporate controller and the fixed asset manager related to the 2016 audit of
depreciation expense:
1. The Company opened all of its old restaurants on June 30, 2008.
2. The Company’s accounting policy requires that assets begin to be depreciated using the straight-line method as soon as they are put into
service.
3. The Company opened three new stores on April 1, 2016.
4. Total new store costs include $1,500,000 for land, $9,400,000 for buildings, $8,500,000 for equipment, and $3,200,000 for furniture and
fixtures.
5. 2016 client-recorded depreciation expense = $4,752,396.
Below is the existing cost basis and accumulated depreciation information (not including the new assets).
Existing Assets
Asset Category Cost Basis Accumulated Depreciation Net Cost Basis Economic Expected Life
Land $2,500,000 � $2,500,000
Building 19,500,000 $5,362,500 14,137,500 20
Equipment 15,242,003 11,975,860 3,266,143 7
Furniture/fixtures 8,259,650 8,259,650 � 5
Totals $45,501,653 $25,598,010 $19,903,643
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17
(
PT