ST & Associates, Chartered Accountants, were conducting the statutory audit of Rose Ltd. for the financial year ended 31st March, 2026. During…
CA Intermediate · Auditing and Ethics · MTP · September 2026
ST & Associates, Chartered Accountants, were conducting the statutory audit of Rose Ltd. for the financial year ended 31st March, 2026. During the audit, the auditor compared various items appearing in the Statement of Profit and Loss for the current year with those of the previous year. The auditor observed significant changes in gross profit margin, selling expenses and administrative expenses as compared to the preceding year. To obtain a better understanding of these fluctuations, the auditor computed various expense ratios and compared them with corresponding ratios of the previous year. Certain unusual trends and variations were noticed, particularly in relation to sales growth and profitability. The auditor therefore decided to investigate the reasons for such variations and evaluate whether these differences were supported by valid business reasons or indicated possible misstatements in the financial statements. In the context of the above, explain the purpose of applying analytical procedures.
Suggested Answer and Working Notes:
Purpose of Applying Analytical Procedure: Analytical procedures use comparisons and relationships to assess whether account balances or other data appear reasonable. The auditor of Rose Ltd. would achieve the following by carrying out the comparison stated in the question: (i) If balances included in the Statement of Profit and Loss of an entity are compared with those contained in the Statement of Profit and Loss with that of the previous period, it would be possible to find out the reasons for increase or decrease in the amount of profits of those years. (ii) By setting up certain expenses' ratios on the basis of balances included in the Statement of Profit and Loss, for the year under audit, comparing them with the same ratios for the previous year, it is possible to ascertain the extent of increase or decrease in various items of expenditure in relation to sales and that of trading profit in relation to sales. (iii) If differences are found to be material, the auditor would ascertain the reasons thereof and assess whether the accounts have been manipulated to inflate or suppress profits. (iv) It would be possible to identify the existence of unusual transactions, amounts, ratios and trends that might indicate matters that have audit implications. In the given case of Rose Ltd., the auditor's comparison of current year and previous year figures and computation of various expense ratios would help in identifying reasons for fluctuations in profits and expenses. Further, investigation of material differences and unusual trends would enable the auditor to detect possible manipulation of accounts and identify matters having audit implications, thereby enhancing the effectiveness of the audit.
Topics: Audit Evidence
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