Northwest Bank Case

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 threshold for tolerable
misstatement. Materiality is defined by FASB 2 as the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement. The first step in applying materiality is to set preliminary judgment about materiality. SAS 107 (AU 312) requires auditors to decide on the combined amount of misstatements in the financial statements that they would consider material early in the audit as they are developing the overall strategy for the audit. For NWB the tolerable misstatement is $525,000 and since our recalculations exceed the tolerable misstatement we are reasonable assured that there is a material misstatement in light of this new information. It means that either interest was received and not accounted for or interest was not received and further scope is required regarding interest receivables and cash.

Analytical procedures use comparisons and relationships to assess whether account balances or other data appear reasonable compared to the auditor’s expectations. Analytical procedures are so important that they are required during the planning and completion phases on all audits. In case 8.2 we will act as the audit team and perform analytical procedures to develop expectations for loan interest income for Northwest Bank.