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SA 520 — Analytical Procedures

Think of analytical procedures as the auditor's version of a sanity check — before diving into detailed vouching, you step back and ask: does this data even make sense? That's the heart of SA 520.

SA 520 requires analytical procedures at two mandatory stages and permits them at a third. First, during risk assessment (planning stage) — here, you use them to understand the client's business and spot areas that need more attention. Second, at the overall review stage (near completion) — you check that the final financial statements are consistent with your understanding of the entity. These two are compulsory. Third, analytical procedures can optionally be used as substantive procedures (instead of, or alongside, detailed tests of transactions) — but only when they're more efficient and effective.

The standard identifies several types of analytical procedures: ratio analysis (gross profit ratio, current ratio), trend analysis (comparing this year's figures to last year's), reasonableness tests (estimating expected interest expense based on average loan balance × rate), and regression analysis (more advanced, rarely tested at Inter level). The key concept is expectation — you form an expectation of what a figure should be, compare it to what it is, and investigate any significant differences beyond a pre-set threshold of acceptable difference.

When using analytical procedures as substantive procedures, SA 520 says four things must be considered: (1) the suitability of the procedure for the assertion being tested, (2) the reliability of the data used, (3) whether the expectation is precise enough to detect a material misstatement, and (4) the acceptable amount of difference without investigation. If you find an unusual fluctuation and management's explanation is plausible, you still need corroborating audit evidence — you can't just accept what the client says. This is a favourite 4-mark exam question — 'What should an auditor do when analytical procedures reveal significant unexpected fluctuations?' Answer: obtain explanations, corroborate them with evidence, and if not satisfactorily explained, consider revision of risk assessment.

📊 Worked example

Example 1 — Reasonableness Test on Interest Expense

Setup: Rajesh & Co. Pvt. Ltd. has an average loan balance of ₹40,00,000 during FY 2024-25 at 12% p.a. The financial statements show interest expense of ₹7,20,000. Your threshold of acceptable difference is ₹20,000.

Working:

  • Expected interest = ₹40,00,000 × 12% = ₹4,80,000
  • Reported interest = ₹7,20,000
  • Difference = ₹7,20,000 − ₹4,80,000 = ₹2,40,000
  • Threshold = ₹20,000
  • ₹2,40,000 >> ₹20,000 → Significant unexplained difference

Answer: The auditor must investigate — ask management for explanation (e.g., additional loan taken mid-year, penal interest, etc.), then corroborate with loan statements and bank confirmations. Do not accept the explanation without evidence.

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Example 2 — Trend Analysis on Gross Profit Ratio

Setup: Ms. Iyer is auditing a retail firm. GP ratio for FY 2023-24 was 28%. For FY 2024-25 it is 19%. Industry average is 26%.

Working:

  • FY24 GP% = 28%, FY25 GP% = 19% → Drop of 9 percentage points
  • Compared to industry: client is 7 points below average
  • This is a red flag — possible causes: unrecorded purchases, fictitious sales, theft, or genuine price pressure

Answer: Ms. Iyer must set this as a higher-risk area, extend substantive procedures (detailed testing of purchases and sales), and obtain management's explanation with corroborating evidence such as supplier invoices and price lists.

⚠️ Common exam mistakes

  • Students think analytical procedures are optional throughout the audit — Wrong. They are mandatory at the risk assessment stage and at the overall review stage. Only their use as substantive procedures is the auditor's choice.
  • Confusing 'explanation' with 'evidence' — Don't write that the auditor 'accepts management's explanation.' SA 520 requires the auditor to corroborate that explanation with independent evidence before concluding.
  • Forgetting the threshold of acceptable difference — Many students describe the comparison step but omit this concept. Always mention that differences are investigated only when they exceed a pre-determined threshold; minor fluctuations are expected.
  • Writing that analytical procedures replace tests of details entirely — They can reduce the extent of tests of details, but for high-risk assertions (e.g., existence of debtors), tests of details remain necessary alongside or instead of analytical procedures.
  • Mixing up SA 520 with SA 315 — SA 315 covers risk assessment procedures broadly; SA 520 specifically governs analytical procedures as a technique. In exam answers, cite SA 520 when the question is about ratio/trend analysis or investigating fluctuations.
📖 Reference: SA 520 — Institute of Chartered Accountants of India
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