ISA 520

Analytical Procedures

1Objective and scope

ISA 520 deals with the auditor's use of analytical procedures as substantive procedures (substantive analytical procedures) and with the analytical procedures performed near the end of the audit that assist the auditor in forming an overall conclusion on the financial statements. The use of analytical procedures as risk assessment procedures is dealt with in ISA 315 (where they are mandatory); ISA 330 deals with the choice between substantive analytical procedures and tests of details. Analytical procedures range from simple comparisons (this year against last year, against budget, against the industry) to complex models (a regression of energy cost on production volume) and relationships between financial and non-financial data (payroll against headcount, hotel revenue against rooms and occupancy).

The objectives are to obtain relevant and reliable audit evidence when using substantive analytical procedures, and to design and perform analytical procedures near the end of the audit that assist the auditor in forming an overall conclusion as to whether the financial statements are consistent with the auditor's understanding of the entity.

2Key definitions

3Requirements

Substantive analytical procedures

When designing and performing substantive analytical procedures, alone or in combination with tests of details, the auditor:

• Determines the suitability of the particular procedure for the given assertions, taking account of the assessed risks and any tests of details for those assertions. Analytical procedures suit predictable relationships (rental income from a fixed portfolio, interest on a fixed loan, depreciation); they do not suit assertions where the auditor needs to detect small misstatements or where relationships are unstable.
• Evaluates the reliability of the data from which the expectation is developed, taking account of its source (external data such as industry statistics is more reliable than internal budgets), comparability (a broad industry ratio may not fit a niche business), the nature and relevance of the information available, and the controls over its preparation, which may need to be tested.
• Develops an expectation of recorded amounts or ratios and evaluates whether the expectation is sufficiently precise to identify a misstatement that, individually or in aggregate with others, may cause the financial statements to be materially misstated. Precision depends on the accuracy with which results can be predicted, the degree to which information can be disaggregated (monthly, by product, by location), and the availability of information.
• Determines the amount of any difference between recorded amounts and expected values that is acceptable without further investigation, influenced by materiality and the desired level of assurance; the lower the acceptable difference, the more persuasive the procedure.

Analytical procedures that assist an overall conclusion

The auditor designs and performs analytical procedures near the end of the audit that assist in forming an overall conclusion as to whether the financial statements are consistent with the auditor's understanding of the entity. They are similar to the risk assessment procedures at planning: comparing the final financial statements with the expectations formed and the results obtained during the audit, computing key ratios (gross margin, receivable days, current ratio, gearing) and evaluating whether the picture makes sense. They may identify a previously unrecognised risk of material misstatement, in which case the auditor revises the risk assessment and plans further procedures under ISA 315.

Investigating results

If analytical procedures identify fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount, the auditor investigates by inquiring of management and obtaining appropriate audit evidence relevant to management's responses (corroborating them with other evidence obtained during the audit or with new evidence), and performing other audit procedures as necessary in the circumstances, where management cannot explain or the explanation and its supporting evidence are inadequate. A plausible explanation from management is inquiry only; it does not become evidence until corroborated.

4Documentation and reporting

The working paper for a substantive analytical procedure records the assertion and the objective, the data used and the assessment of its reliability, the expectation and how it was developed, the threshold and the reasons for it, the comparison with the recorded amount, the investigation of differences (management's explanation, the corroborating evidence, further procedures) and the conclusion, together with any misstatement identified and carried to the ISA 450 schedule. The final analytical review is documented as a memorandum with the key ratios and the auditor's evaluation of consistency with the understanding of the entity, and it feeds the ISA 570 going concern assessment and the overall conclusion under ISA 330 and ISA 700. Nothing from ISA 520 appears in the auditor's report directly.

5Examinable focus