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ISA 520 Analytical Procedures

ISA 520 Analytical Procedures
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ISA 520, “Analytical Procedures,” is an auditing standard issued by the International Auditing and Assurance Standards Board (IAASB) that provides guidance to auditors on the use of analytical procedures as part of their audit procedures. Analytical procedures are used by auditors to obtain audit evidence by evaluating financial information through analysis of relationships among data, or by comparing financial information with expectations developed by the auditor. Analytical procedures are used in different stages of an audit, including planning, substantive testing, and overall review.

 

Definition:

Analytical procedures are defined as the evaluation of financial information through analysis of plausible relationships among both financial and non-financial data, and by comparing the information with expectations developed by the auditor. These procedures assist the auditor in understanding the client’s business, identifying potential risks, and assessing the reasonableness of financial statement amounts.

 

Explanation:

Analytical procedures involve the use of various analytical techniques, such as trend analysis, ratio analysis, reasonableness analysis, and regression analysis, to compare financial data and identify any unusual or unexpected fluctuations or trends. These procedures are performed by auditors to obtain audit evidence that supports the assertion of the financial statements being audited.

Analytical procedures are used in the planning phase of an audit to assess the overall reasonableness of financial statement amounts, identify areas of potential risk, and develop expectations about the financial information. During substantive testing, analytical procedures are used as substantive audit procedures to obtain evidence about the accuracy and completeness of specific account balances or classes of transactions. Finally, analytical procedures are used in the overall review stage to provide a final assessment of the financial statements as a whole.

 

Examples:

Trend analysis:

The auditor may compare financial data from prior years’ financial statements to the current year’s financial statements to identify any significant changes or trends. For example, the auditor may compare the sales revenue of the current year with the sales revenue of the previous year to assess whether the increase or decrease is reasonable and consistent with the client’s business operations.

Ratio analysis:

The auditor may calculate and compare financial ratios, such as liquidity ratios (e.g., current ratio, quick ratio), profitability ratios (e.g., gross profit margin, return on equity), and efficiency ratios (e.g., inventory turnover, days sales outstanding), to assess the financial health and performance of the client’s business. Significant changes in these ratios may indicate potential risks or irregularities that require further investigation.

Reasonableness analysis:

The auditor may compare financial data with industry benchmarks or external data to assess the reasonableness of financial statement amounts. For example, the auditor may compare the client’s cost of goods sold percentage with industry averages to determine if it falls within the expected range. Deviations from industry benchmarks or external data may indicate potential risks or errors in the financial statements.

Regression analysis:

The auditor may use statistical techniques, such as regression analysis, to identify relationships between financial variables and develop expectations about the financial information. For example, the auditor may use historical data to develop a regression model that predicts the client’s sales revenue based on factors such as the number of customers, average selling price, and market conditions. The actual sales revenue can then be compared with the expected sales revenue to assess the reasonableness of the financial information.

 

Case Studies:

XYZ Corporation is a manufacturing company that produces electronic devices. As part of the audit planning procedures, the auditor performs trend analysis on XYZ Corporation’s sales revenue over the past three years. The auditor notices that the sales revenue has been declining steadily over the years, which raises concerns about the company’s financial performance and potential risks associated with declining sales. The auditor decides to perform additional substantive testing procedures to assess the accuracy and completeness of the sales revenue recorded in the financial statements.

ABC Bank is a financial institution that provides various banking services. As part of the overall review procedures, the auditor performs ratio analysis on ABC Bank’s financial ratios, including the capital adequacy ratio, asset quality ratio, management efficiency ratio, and earnings performance ratio. The auditor compares these ratios with industry benchmarks and external data to assess the financial health and performance of ABC Bank. The auditor identifies that ABC Bank’s capital adequacy ratio has fallen below the industry average, indicating potential risks related to the bank’s capital adequacy. The auditor decides to perform additional audit procedures to further investigate the bank’s capital adequacy and assess the impact on the financial statements.

LMN Corporation is a retail company that operates multiple stores. As part of the substantive testing procedures, the auditor performs reasonableness analysis on LMN Corporation’s inventory turnover ratio by comparing it with industry averages. The auditor notices that LMN Corporation’s inventory turnover ratio is significantly lower than the industry average, which raises suspicions about the company’s inventory management and potential risks related to obsolete or slow-moving inventory. The auditor decides to perform additional audit procedures, such as inventory observation and inventory valuation testing, to further assess the accuracy and valuation of the inventory recorded in the financial statements.

 

In conclusion, ISA 520 “Analytical Procedures” provides auditors with guidance on how to use analytical procedures as part of their audit procedures. Analytical procedures involve the evaluation of financial information through analysis of relationships among data and by comparing the information with expectations developed by the auditor. Examples of analytical procedures include trend analysis, ratio analysis, reasonableness analysis, and regression analysis. Case studies demonstrate how auditors can use analytical procedures to identify potential risks, assess the reasonableness of financial statement amounts, and obtain audit evidence to support their audit opinion. By effectively using analytical procedures, auditors can enhance the quality of their audits and provide reliable assurance on the financial statements of their clients.