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Microlesson · 5-min read

SA-520: Analytical Procedures

## SA-520: Analytical Procedures (SAP)

### Definition

Evaluation of financial information through analysis of plausible relationships among financial and non-financial data, together with investigation of identified fluctuations or relationships inconsistent with other information.

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### Objective

a. Obtain relevant and reliable audit evidence using SAP

b. Design and perform ARP near the end of audit to assist in drawing overall conclusions

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### Timing of SAP

An experienced auditor applies SAP at all three stages:

1. Planning — understanding the client's business; identifying areas of potential risk; determining NTE of other procedures

2. Testing — as substantive analytical procedures (under SA-330)

3. Completion — overall review to form a final conclusion

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### Techniques of Analytical Procedures

TechniqueKey Features
Trend AnalysisCompares current data with prior period(s); most commonly used; current balances should move in line with established trend
Reasonableness TestDoes NOT rely on prior period data; relies on non-financial data of the audit period; most applicable to the income statement
Ratio AnalysisAnalyses relationships between accounts (e.g., Trade Receivables : Sales); ratios compared over time, within the group, or with industry
Structural ModellingStatistical model (e.g., linear regression) using financial and non-financial data to predict current account balances

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### SAP as Substantive Procedures (Under SA-330)

When using SAP alone or combined with TOD, the auditor must go through four determinations:

#### 1. Determine Suitability of SAP

  • More suitable when transactions are: high in volume; predictable over time
  • SAP assumes that relationships among data exist
  • Different SAP types provide different levels of assurance
  • Suitability depends on: nature of assertion (Valuation, Presentation & Disclosure) and auditor's RAP
  • If controls over sales are weak (high CR): focus more on TOD rather than SAP for Trade Receivables
  • SAP can be combined with TOD on the same assertion
  • Example: Examining valuation of TR — subsequent cash receipts (TOD) + ageing analysis (SAP)

#### 2. Determine Reliability of Data

1. Source — independent external source is more reliable

2. Comparability — data must be comparable (specialized products need careful comparison)

3. Nature & relevance — budgets must reflect expectations, not aspirational goals

4. Controls over preparation, maintenance, and review of budgets

#### 3. Determine Acceptable Difference (Recorded vs. Expected)

  • Influenced by: materiality level; desired assurance level; possibility of misstatement
  • Higher assessed risk → accept lower difference → need more persuasive evidence

If difference is unacceptable (significant):

1. Inquire with management; corroborate response with other audit evidence

2. Perform additional procedures (e.g., external confirmation) if:

  • Management fails to provide an explanation, OR
  • Management's explanation + other AE is not adequate

#### 4. Evaluate Whether Expectation is Sufficiently Precise

ConsiderationImplication
GP margin → more consistentBetter for SAP than discretionary expenses (R&D, advertising)
Degree of disaggregationSAP more useful on individual items than on aggregate FS
Account typeIncome statement (accumulated transactions) > Balance sheet (point in time, management judgment)

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### Factors to Consider When Designing SAP

1. Availability of data — must be relevant and reliable

2. Disaggregation — more disaggregated data = more useful SAP

3. Account type — income statement more predictable than balance sheet

4. Frequency — routine/numerous transactions are easier to predict than non-routine

5. Predictability — sales and cost of sales are highly predictable

6. Nature of assertion — SAP more effective for Valuation and Completeness than for Presentation, Rights & Obligations

7. Inherent risk — if significant risk exists, SAP alone is NOT sufficient; must use TOD

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### SAP in Public Sector Units (PSU)

  • Revenue and expenditure do not always have direct relationships
  • Asset acquisition may not always be capitalized
  • Industry data for comparison may not be available
  • Other relevant relationships: e.g., Cost per km of road construction; number of vehicles acquired vs. retired

Worked example

### Example 1

Reasonableness Test — Payroll Verification: An auditor wants to verify payroll expense without relying on prior year figures. Using non-financial data: number of employees × average salary grade = expected payroll. If actual payroll deviates materially, the auditor investigates further. This is a reasonableness test — it depends on current period non-financial data, not historical trends.

### Example 2

GST Cross-Verification: An auditor applies SAP to independently verify the sales figure. By applying the applicable GST rate to the total GST collected, the auditor derives an expected sales figure. If this does not reconcile with recorded sales, the auditor investigates whether sales have been understated or overstated.

### Example 3

Ratio Analysis — ARTR Comparison: The auditor computes the entity's Account Receivable Turnover Ratio (ARTR) and compares it with: (a) industry average and (b) a similar firm in the same industry. A significantly lower ARTR than the industry average may indicate collection problems, overstatement of receivables, or fictitious debtors — prompting further TOD.

⚠️ Common exam mistakes

  • Confusing Trend Analysis with Reasonableness Test: Trend Analysis relies on prior period data; Reasonableness Test relies on non-financial data of the current audit period only.
  • Using SAP alone for areas with significant inherent risk — SAP alone is never sufficient for significant risk areas; TOD must be designed.
  • Treating balance sheet items as equally predictable as income statement items — balance sheet items reflect a point-in-time position subject to management estimates and are harder to predict.
  • Accepting management's explanation of a significant difference without corroborating it with additional audit evidence.
  • Ignoring disaggregation — SAP applied to total FS figures is far less precise and useful than SAP applied to individual account balances or segments.
Reference: SA-520 — Standards on Auditing — ICAI
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