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The Auditor's Guide to Analytical Procedures Under ISA 520
Complete guide: ISA 520 requirements quick reference, decision flowchart for when to use analytical procedures vs. tests of details, industry-specific ratio checklists for 12 sectors, threshold-setting guide by risk level, sample completed working paper, common quality-review findings, and documentation checklist.
ISA 520 Analytical Review for Construction Entities
Construction audits present unique analytical challenges arising from the project-based nature of the business and the complexity of IFRS 15 revenue recognition for long-term contracts. Under ISA 520, the auditor must develop expectations that reflect how contract revenue is recognised over time based on progress toward completion. Revenue should correlate with costs incurred on active contracts — if total costs to date represent 60% of estimated total costs, approximately 60% of the contract revenue should have been recognised. The auditor should perform a contract-by-contract analytical review for significant contracts, comparing the margin recognition pattern to prior periods and to the original tender margin. Declining margins signal cost overruns, scope changes, or estimation issues that require investigation under ISA 520.7.
Work-in-Progress and Cash Flow Analysis
The amounts due from customers (work-in-progress asset) and amounts due to customers (over-billing liability) are the most critical balance sheet items for construction entities. WIP assets represent revenue recognised in excess of amounts billed — growing WIP balances may indicate delayed billing, disputed amounts, or aggressive revenue recognition. The auditor should analyse WIP ageing and assess collectability. The relationship between WIP movements and revenue recognised provides a crucial analytical check. Retention balances — amounts withheld by customers pending project completion or defects liability periods — should be ageing-analysed and assessed for collectability. Construction entities often operate with significant working capital swings: large receivables from clients, significant payables to subcontractors, and retention assets and liabilities. Cash conversion should be analysed to ensure that recognised profits are translating into cash flows.
Backlog and Pipeline Analysis
The contract backlog — the value of contracted but unperformed work — is a leading indicator for future revenue. The auditor should analyse the backlog-to-revenue ratio for insight into revenue sustainability. A declining backlog without replacement through new contract wins is a potential going concern indicator. Margin expectations from the backlog should be consistent with the entity's historical margin performance and current market conditions. For entities using subcontractors extensively, the subcontractor cost ratio should be stable between periods. Significant increases may signal capacity constraints in the direct workforce or strategic shifts toward a management-contractor model. Changes in the subcontractor mix (fewer, larger subcontracts vs. many smaller ones) have implications for cost control and quality management.
Key Ratios to Monitor for Construction
- Gross margin by contract
- WIP turnover
- Revenue-to-backlog ratio
- Subcontractor cost ratio
- Retention balance ratio
- Days payables outstanding
What Drives Account Fluctuations
Contract wins and completions changing the active project portfolio
Percentage-of-completion estimates affecting revenue recognition
Cost overruns or savings on individual contracts
Subcontractor availability and pricing affecting cost structure
Retention release timing from completed contracts
Seasonal Considerations
Construction activity is affected by weather — cold/wet periods reduce productivity, particularly for outdoor work. Revenue recognition can be lumpy as contracts reach milestone stages. Year-end is a critical point for percentage-of-completion estimates.
Recommended Investigation Thresholds for Construction
| Account Category | Threshold % |
|---|---|
| Revenue | 10% |
| Cost of Goods Sold | 10% |
| Operating Expenses | 15% |
| Current Assets | 10% |
| Equity | 10% |
Regulatory note: Construction entities may be subject to building regulations, safety requirements, and sector-specific licensing. Joint arrangement accounting (IFRS 11) is common for large projects. Revenue from variable consideration (incentive payments, liquidated damages) requires estimation under IFRS 15.
Worked Example: Construction Analytical Review
A commercial construction company specialising in office fit-outs. Overall materiality €600,000, performance materiality €390,000.
Overall materiality: €600,000 | Performance materiality: €390,000 | Threshold: 10%
| Account | PY | CY | Change | % |
|---|---|---|---|---|
| Contract Revenue FLAG | €38,000,000 | €45,000,000 | €7,000,000 | +18.4% |
| Contract Costs — Materials FLAG | €15,200,000 | €18,000,000 | €2,800,000 | +18.4% |
| Subcontractor Costs FLAG | €11,000,000 | €14,500,000 | €3,500,000 | +31.8% |
| Direct Labour | €6,200,000 | €6,800,000 | €600,000 | +9.7% |
| WIP — Due from Customers FLAG | €5,200,000 | €8,500,000 | €3,300,000 | +63.5% |
| Retentions Receivable FLAG | €2,800,000 | €3,200,000 | €400,000 | +14.3% |
| Due to Customers FLAG | €3,400,000 | €2,100,000 | €-1,300,000 | -38.2% |
| Subcontractor Payables FLAG | €3,200,000 | €4,800,000 | €1,600,000 | +50.0% |