Research auditing professional standards and list the requirements related to developing an expectation and conducting analytical procedures when those procedures are intended to provide substantive evidence. What are the advantages of developing an expectation at a detailed level (i.e., using disaggregated data) rather than at an overall or aggregated level?

Question

What will be an ideal response?

Answer 1

Some particularly relevant excerpts from AU-C 520 are provided below:
“A basic premise underlying the application of analytical procedures is that plausible relationships among
data may reasonably be expected to exist and continue in the absence of known conditions to the contrary”
(A6).
“The expected effectiveness and efficiency of a substantive analytical procedure in addressing risks of material
misstatement depends on, among other things, (a) the nature of the assertion, (b) the plausibility and
predictability of the relationship, (c) the availability and reliability of the data used to develop the expectation,
and (d) the precision of the expectation” (A8).
"When designing and performing analytical procedures, either alone or in combination with tests of details,
as substantive procedures in accordance with the clarified SAS Performing Audit Procedures in Response to
Assessed Risks and Evaluating the Audit Evidence Obtained (Redrafted), the auditor should:
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;
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;
c. develop an expectation of recorded amounts or ratios and evaluate whether the expectation is sufficiently precise (taking into account whether substantive 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
d. determine the amount of any difference of recorded amounts from expected values that is acceptable
without further investigation as required by paragraph 7 and compare the recorded amounts, or ratios
developed from recorded amounts, with the expectations" (Paragraph 5).
"When expectations are developed at a more detailed level, it is more likely that the analytical procedure will
more effectively address the assessed risk of misstatement to which it is directed. Monthly amounts may be more
effective than annual amounts, and comparisons by location or line of business usually are more effective than
companywide comparisons. The appropriate level of detail may be influenced by the nature of the entity, its
size, and its complexity. The risk that material misstatements may be obscured by offsetting factors increases as
an entity's operations become more complex and diversified. Disaggregation of the information helps reduce
this risk" (A23).
Generally, the more disaggregated the data the more precise the expectation. Precision is the
auditor’s measure of the potential effectiveness of an analytical procedure, and therefore the degree
of reliance that can be placed on the procedure and the assurance derived from it. Effectiveness
refers to the procedure’s ability to identify accounts with and without misstatements. The AICPA
Auditing Practice Release, “Analytical Procedures,” indicates that other factors that can influence
the degree of precision of an expectation include reliability of the input data, predictability of
the account, and the method used to form an expectation (e.g., simple comparison analysis versus
multiple regression analysis). Thus, the primary advantages associated with a disaggregated or
precise expectation is the quality of the expectation and the level of audit assurance provided by
the procedure. The more precise the expectation the closer the auditor’s independent expectation
should be to the “correct” amount. Significant differences between a precise expectation and
the reported client balance, the more likely the difference relates to a misstatement. Because
precision is associated with the quality of the evidence, the more precise the expectation the
more assurance provided.