## Using Analytical Procedures as a Substantive Test — Four-Step Process
When the auditor chooses to rely on AP as a substantive procedure (not merely for risk assessment), SA 520 requires four specific steps:
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### Step 1 — Determine Suitability of the Specific AP
AP is more suitable when:
- There is a large volume of predictable transactions (e.g., utility expense, payroll).
- A stable relationship among data elements is expected to continue in the absence of known contrary conditions.
Suitability depends on:
- Auditor's assessment of the likelihood of detecting material misstatement through that procedure.
- The nature of the assertion being tested (e.g., completeness vs. existence).
> Note: In some cases, even an unsophisticated predictive model can be highly effective.
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### Step 2 — Evaluate Reliability of Data (Mnemonic: SCNC)
Before using data to form an expectation, the auditor evaluates:
| Factor | Detail |
|---|---|
| (S) Source | External sources are more reliable than internal sources |
| (C) Comparability | Industry comparisons must be relevant (same industry, size, geography) |
| (N) Nature & Relevance | Data must be pertinent to the account/assertion being tested |
| (C) Control | Whether budget figures reflect expected outcomes vs. aspirational targets; controls over preparation of data |
> Auditor may test the operating effectiveness of the entity's controls over information preparation to justify relying on internally prepared data.
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### Step 3 — Develop a Sufficiently Precise Expectation
- The auditor must develop an expected amount or ratio from the reliable data.
- The expectation must be precise enough that any material misstatement would create a detectable difference between expected and recorded amounts.
- If the precision band is too wide, the procedure will not catch a material error.
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### Step 4 — Determine Acceptable Difference (Threshold)
- Set the maximum difference between Expected Amount and Recorded Amount that can be accepted without further investigation.
- Any difference exceeding this threshold must be investigated.
> Key formula: `Unexplained Difference = Expected Amount − Recorded Amount`
> If |Unexplained Difference| > Threshold → Investigate further.