ISA 520 Analytical procedures provides guidance to auditors on the use of analytical procedures during the course of the external audit.
Required:
When using analytical procedures as substantive audit procedures, list and briefly explain with examples THREE factors to consider when determining the extent of reliance that can be placed on the results of such procedures. (6 marks)
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Factors to consider when assessing the reliance that can be placed on the results of analytical procedures.
(1) Materiality of the items involved
If inventory balances are material, then auditors should not rely solely on analytical procedures.
(2) Other audit procedures
In the audit of receivables, other audit procedures such as the review of subsequent cash receipts may confirm or dispel questions arising from the application of analytical procedures to an aged profile of customers’ accounts.
(3) Accuracy of predictions
Auditors would expect greater consistency in comparing the relationship between gross profit and sales from one period to the next than in comparing discretionary expenses such as research costs or advertising expenditure.
(4) Frequency with which relationship is observed
A pattern repeated monthly as opposed to annually (for example, payroll costs).
(5) Assessments of inherent and control risks
If internal controls over sales order processing are weak, and control risk is assessed as high, the auditors may rely more on test of individual transactions or balances than on analytical procedures.
(Any 3 points)