Plausibility, Predictability, and Precision: Proposal to Modernize Substantive Analytical Procedures

Remarks as prepared for delivery

Good afternoon. Today, the staff is recommending that the Board issue a proposal to modernize a standard written nearly 40 years ago.  

The Board incorporated this decades-old standard into its audit standards in 2003. In particular, the proposed standard focuses on the auditor’s responsibilities when designing and performing what are typically known as “Substantive Analytical Procedures.”    

The staff have concluded that it is necessary to replace the decades-old interim standard in its entirety to update,  clarify, and  strengthen the auditor’s responsibility when designing and performing audit procedures  that involve an auditor’s use of relationships to develop a prediction of amounts or balances recorded in a company’s books and records.  

For example, under the proposal, the auditor must answer the following questions:    

• Do I have a sufficient basis to determine a plausible and predictable relationship?
• Can I develop a sufficiently precise expectation of amounts or balances that should have been recorded in the company’s books and records?
• Am I able to determine an appropriate threshold for investigating deviations for that expectation?

If the auditor can sufficiently satisfy all those questions, the auditor must then perform additional procedures to evaluate those deviations.

The proposed standard underscores and reinforces the importance of auditor judgement and professional skepticism. For example, auditors may not cherry-pick information and must incorporate all relevant information when developing their best estimate expectation.

This requires the auditor to understand the company, its legal and economic environment, and events or activities that may affect the auditor’s ability to determine whether a logical relationship is both plausible and forms a basis for the prediction.

Moreover, the auditor may not short-cut the procedures, because the proposed standard would require auditors to incorporate a feedback loop to update this understanding and to critically evaluate any company amounts that differ from their expectations. For example, auditors would not be able to sustain a logical relationship predicated on sales trends occurring prior to the impact of a global pandemic.

Additionally, the proposed standard specifies that the auditor may not use the company’s amounts or information based on the company’s amounts to develop their expectation.

Importantly, the staff is also proposing an amendment to AS 2301 Response to Risk of Material Misstatement. The proposed amendment would require an auditor to examine relevant information that the company received from an external source, when relying on that externally sourced information for their procedures.

In conclusion, the proposed standard equips the auditor with a principles-based framework for developing a prediction for an amount or balance that they expect to see in the company books and records. If a prediction can be developed, the auditor must then compare and evaluate the auditor’s expectation against the company’s actual numbers. 

These changes should provide opportunities for efficiency, in addition to increased precision, and I look forward to receiving public comment on the proposal.

I would like to end by acknowledging the efforts and dedication of our staff:  from the Office of the Chief Auditor:   Dima Andriyenko,  Dominika Taraszkiewicz, Donna Silknitter, Karen Wiedemann, and  Sarah Madris;   from the Office of Economic and Research Analysis: Erik Durbin,  John Cook, Carrie von Bose, and Dylan Rassier;  from the Office of the General Counsel:   Connor Raso,  Katherine Kelly,  Jennifer Williams, and  Katie Reilly.  

And I would also like to thank the many individuals from the Division of Registration and Inspection and the individuals from the Division of Enforcement and Investigations who helped with the project.