ISA 520 Analytical Procedures requires that the auditor performs analytical procedures during the initial risk assessment stage of the audit. These procedures, also known as preliminary analytical review, are usually performed before the year-end, as part of the planning of the final audit.
The following are reasons for performing analytical procedures as part of risk assessment:
- It is mandatory to perform analytical procedures as part of risk assessment. Analytical procedures can help the auditor to develop an understanding of the entity, and highlight matters of which the auditor was previously unaware. Procedures are therefore invaluable in terms of developing knowledge about the operations and performance of the entity. For example, this may be particularly important in the case of a new audit client, when analytical procedures such as a comparison of margins made by the entity with those made by its competitors will provide the auditor with some degree of knowledge about the relative performance of the entity within its business environment.
- In addition, performing analytical procedures at the planning stage may indicate aspects of the financial statements which appear to carry a high risk of material misstatement. This would happen when unexpected trends and unusual relationships between pieces of financial data were revealed by the analytical procedures. For example, procedures may reveal that revenue has increased by 20% compared to the previous year, but that the budgeted increase was only 5% and the industry average increase was only 8%. These results could indicate the possible overstatement of revenue, and thus the auditor has been alerted to a possible material misstatement in the financial statements.
- Help the auditor to identify and to prioritize potential areas of risk, and to
- Help an auditor to develop an appropriate audit strategy to minimize detection risk.