ISA 520 – Analytical Procedures

1 Purpose of Analytical procedures

Analytical procedures can be used by the auditor at different stages of audit engagement such as:

  • Analytical procedures applied in understanding the entity and its environment which helps auditor in assessing risk of material misstatements.
  • Substantive analytical procedures applied in response to assessed risk of material misstatement
  • Analytical procedures applied at overall review stage of the audit which may indicate previously unrecognized risk of material misstatement and to ensure that financial statements are consistent with auditor’s expectations.

ISA 520 however, deals with such analytical procedures that are applied as substantive procedures (a.k.a. substantive analytical procedures). How analytical procedures can help auditor in other ways at different stages of audit is described in the auditing standard relevant to that stage of audit. For example ISA 315 discusses the use of analytical procedures in assessing risk of material misstatements.

1.1 Analytical procedures – defined

Analytical procedures mean:

The evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.

In simple words, analytical procedures are such evaluations that are carried by studying the relationships that exists among both financial and non-financial information of the entity. For example: salary expense and number of employees working in an entity.

For example;

Examining the relationship between sales revenue generated and selling expenses incurred over the past few years. Once the relationship is inferred from past information, it helps the auditor to identify inconsistent fluctuations i.e. if selling expenses has increased at same rate as sales revenue then this year’s 20% increase in revenue must meet with 20% increase in selling expenses. If this is not the case then it is a matter to be observed closely as it may contain material misstatements either in sales revenue figure or selling expenses.

1.1.1 Considerations of comparison

For evaluation purposes financial information of an entity may be compared with:

  • Prior periods’ financial information of the same entity. For example last year’s financial statement
  • Budgets or forecasts of the same entity. For example sales budget for current quarter ended
  • Expectations of auditor that he made through understanding of entity and its environment. For example net realisable of inventory.
  • Similar industry information i.e. comparing entity’s information with the information of other entities in the same industry or size or geographical location. For example comparing receivable turnover period of the entity under consideration with the turnover period of similar entities, consistency of credit terms with industrial norms etc.

It includes the study of relationship that different interconnected sets of information has. It also includes evaluation of fluctuations in the financial or non-financial data and observing whether the expected impact on connected business areas is evident or not.

1.1.2 Study of relationship

Analytical procedures involve study of relationship that exists:

  • with in financial information among it’s different elements that can be expected by studying entity’s past experience. For example gross mark up, credit sales and bad debts, sales and sales return etc.
  • between financial and non-financial information. For example overtime paid and orders fulfilled. Machine depreciation expense and the number of hours machine used.

This evaluation of relationships and fluctuations may be conducted using different techniques that may range from simple comparisons to complex statistical techniques. Analytical procedures can be applied to financial statements as a whole or to a financial statement of a component i.e. subsidiary’s financial statements or to different elements of financial statements i.e. assets, capital, liabilities etc.