AU-C section 520, Analytical Procedures, covers the analytical procedures an auditor uses as substantive procedures and in the overall review near the end of an audit of a nonissuer. Analytical procedures are evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data. They include comparisons with prior periods, budgets and industry data, ratios, and trend analysis, and they include the investigation of fluctuations that are inconsistent with other information.
This page paraphrases the standard. Read AU-C 520 in AICPA Professional Standards before relying on any point here.
What is the objective of AU-C 520?
The auditor's 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 help the auditor form an overall conclusion about whether the financial statements are consistent with the auditor's understanding of the entity.
Where do analytical procedures appear in an audit?
Analytical procedures play three roles. AU-C 520 itself deals with two of them.
| Stage | Purpose | Where it is covered |
|---|---|---|
| Risk assessment | Identify unusual or unexpected relationships that may indicate risks of material misstatement | AU-C 315 |
| Substantive | Obtain evidence about assertions | AU-C 520 and AU-C 330 |
| Overall review | Conclude near the end of the audit whether statements are consistent with the auditor's understanding | AU-C 520 |
Risk assessment analytics are required under AU-C 315. Substantive analytics are optional. They are one choice among tests of details, and the auditor chooses them when they will be effective and efficient. See AU-C 315 risk assessment.
What does the auditor do before relying on a substantive analytic?
When designing substantive analytical procedures, either alone or with tests of details, the auditor does the following.
- Determine suitability. Whether substantive analytical procedures are suitable for given assertions, taking into account the assessed risks of material misstatement and any tests of details for the same assertions.
- Evaluate reliability of data. The reliability of the data from which the auditor's expectation will be developed, considering the source, comparability, nature and relevance of the information, and the controls over its preparation.
- Develop an expectation. An expectation of recorded amounts or ratios that is sufficiently precise to identify a misstatement that, individually or in aggregate with others, may cause the financial statements to be materially misstated.
- Set a threshold. The amount of any difference from expectation that can be accepted without further investigation.
After performing the procedure, the auditor compares recorded amounts or ratios with the expectation.
Precision is the point
An analytic that compares this year to last year with no thought about what should have changed is rarely a substantive procedure. It is closer to a risk-assessment tool. For evidence, the auditor needs an expectation built from data the auditor has reason to trust, independent of the recorded amount, and predictive enough to catch a misstatement of the relevant size.
The standard's guidance notes that substantive analytics tend to suit large volumes of transactions that are predictable over time, such as payroll, interest, rent, and revenue with stable pricing. They fit poorly where relationships are weak, where the data is unreliable, or where the risk is significant.
The threshold should be tied to tolerable misstatement
The threshold for investigation cannot exceed what the auditor can accept given the assessed risk. A common practice is to set it as a portion of performance materiality or tolerable misstatement, tighter for higher assessed risk. The standard does not give a percentage, and any percentage a firm uses is practice. See AU-C 320 materiality.
What happens when results differ from the expectation?
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
- performing other audit procedures as necessary in the circumstances
Management's explanation is a starting point, not evidence by itself. Corroborate it with documents, outside data, or other procedures. If the explanation is vague, such as "volume was higher", the auditor asks for the supporting numbers.
A worked example
Illustrative figures. A client has 40 salaried employees and 22 hourly employees. The team wants to test payroll expense with an analytic instead of a full test of details.
| Step | Detail |
|---|---|
| Data | Payroll register headcount by month, pay rates from HR files, hours from timekeeping, tax rates from published schedules |
| Expectation | Headcount by month times average rate, plus overtime computed from hours, plus employer taxes at statutory rates |
| Expected expense | $4,310,000 |
| Recorded expense | $4,395,000 |
| Difference | $85,000 |
| Threshold | $60,000 (tied to tolerable misstatement for payroll) |
The difference exceeds the threshold, so the team investigates. Management says a bonus accrual was recorded in December. The team examines the board approval and the calculation, and recomputes it. That explains $70,000. The remaining $15,000 is below the threshold. The team documents the expectation, the data sources, the threshold, the investigation and the conclusion.
What is the overall review?
Near the end of the audit, the auditor designs and performs analytical procedures that assist in forming an overall conclusion about whether the financial statements are consistent with the auditor's understanding of the entity.
Revenue, margins and balance sheet ratios should all fit what the team learned. If it turns up a previously unrecognized risk of material misstatement, the auditor revises the assessment and modifies the planned procedures. Teams often use the same analytics from planning, updated with final numbers.
What must be documented?
The auditor documents the expectation and the factors considered in developing it, the results of comparing the expectation with the recorded amounts, and any additional procedures and their results. AU-C 230 governs documentation. In practice the file should also record the data sources and the basis for the threshold. See AU-C 230 audit documentation.
Common weaknesses in analytics
Practice checks, not requirements of the standard. Gaps to avoid:
- Prior-year comparison presented as a substantive analytic, with no independent expectation
- No threshold documented, or a threshold larger than tolerable misstatement
- Management's explanation accepted without corroboration
- Reliability of the underlying data not addressed
- Analytics used where the risk was significant and a test of details was needed
- No documented overall review near the end of the audit
Related
- AU-C 315 risk assessment and SAS 145
- AU-C 320 materiality
- AU-C 450 evaluation of misstatements
- AU-C 530 audit sampling
- Substantive testing vs test of controls
- Financial ratio calculator
Sources
- AICPA, AU-C Section 520, Analytical Procedures
- AICPA, AU-C Section 315 and AU-C Section 330
- AICPA, AU-C Section 320, Materiality in Planning and Performing an Audit
- AICPA, AU-C Section 230, Audit Documentation
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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error