Developing Expectations for Analytical Procedures

Case 8.2

Northwest Bank

Developing Expectations for Analytical Procedures

Analytical procedures are used for many purposes, such as to understand the clients industry or business, assess the entity’s ability to continue as a going concern, and to indicate the presence of possible misstatements. The audit approach for Northwest Bank calls for the audit team to gain assurance on the fairness of loan interest income primarily through the performance of analytical procedures. Additional detailed testing will only be performed if analytical procedures suggest interest income is materially misstated. A misstatement of $525,000 is considered material.

The audit team developed an expectation for loan interest income using the average loan volume multiplied by the weighted average interest rate. By using this analytical procedure we were able to develop that 2004 and 2005 interest income analytics were immaterial. However, changes in real estate and agricultural industries indicate that people are not paying back loans. This has an affect on interest income. Therefore we had to do further research. By finding detailed information on quarterly expected interest income recorded in 2005 you are able to tell that there has been a default on loans and the weighted interest rates have been increase also due to higher loan volumes.

Analytical procedures are also used for recalculations. Recalculation involves rechecking a sample of calculations made by the client. Rechecking client calculations consists of testing the client’s arithmetical accuracy and includes such procedures as extending sales invoices and inventory, adding journals and subsidiary records, and checking the calculations of depreciation expense and prepaid expenses. A considerable portion of auditors’ recalculation is done by computer assisted audit software. In the case of Northwest bank we are recalculating interest income by using 2005’s actual quarterly loan balances and actual rates rather than only the average aggregate loan balances and interest averages. In our recalculations we were able to determine that the balances surpass the $525,000