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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 Manufacturing Entities
Manufacturing audits demand particular attention to the relationship between production inputs and outputs. Under ISA 520, the auditor must develop expectations that reflect the operational realities of the production environment. For manufacturing entities, this means understanding how raw material procurement, labour deployment, and overhead absorption translate into cost of goods sold and inventory movements. The gross margin percentage is the single most important analytical indicator — any shift signals changes in pricing, product mix, input costs, or production efficiency that require investigation. A manufacturing entity reporting a 2% gross margin decline on €50M revenue represents a €1M shift that almost certainly exceeds materiality and demands explanation.
Key Ratios and Metrics for Manufacturing Audits
Inventory turnover is the second critical metric. Manufacturing entities hold three distinct inventory categories — raw materials, work-in-progress (WIP), and finished goods — and each tells a different story. Increasing raw materials with stable production may signal procurement timing changes or speculative buying. Growing WIP balances could indicate production bottlenecks or changes in product complexity. Finished goods accumulation might signal demand weakness or quality issues preventing dispatch. The auditor should calculate turnover days for each category separately and compare to prior periods. Fixed asset turnover (revenue divided by net PP&E) measures capital efficiency and should remain relatively stable unless the entity has made significant capital investments or experienced capacity changes. Production overhead absorption rates should be analysed against actual production volumes — under-absorption in periods of reduced output increases COGS and reduces margins, which the auditor should verify against management's explanations.
What Drives Account Fluctuations in Manufacturing
Manufacturing revenue fluctuations are driven by volume, price, and product mix. The auditor should disaggregate revenue analysis where possible: has revenue increased because of volume growth, price increases, or a shift to higher-value products? Each driver has different implications for other financial statement lines. Volume increases should correlate with proportional increases in raw materials and direct labour. Price increases should improve gross margin without corresponding cost increases. Product mix changes affect both revenue composition and gross margin percentages. On the cost side, raw material costs are subject to commodity price volatility — steel, polymers, electronic components, and agricultural inputs can fluctuate significantly between periods. The auditor should consider whether input cost changes have been passed through to customers (maintaining margins) or absorbed (reducing margins). Energy costs are increasingly significant for manufacturing entities and may warrant separate analysis, particularly for energy-intensive processes such as smelting, kiln operations, or chemical processing.
Key Ratios to Monitor for Manufacturing
- Gross margin
- Inventory turnover
- WIP ratio
- Fixed asset turnover
- Days inventory outstanding
- Production overhead ratio
What Drives Account Fluctuations
Production volume changes driving raw material and labour cost fluctuations
Input cost volatility (raw materials, energy) affecting COGS composition
Product mix shifts altering gross margin percentages
Capital expenditure cycles impacting depreciation charges
Seasonal production patterns creating working capital swings
Seasonal Considerations
Manufacturing entities often show seasonal production cycles — pre-season stock build-ups cause inventory peaks, while post-season drawdowns affect COGS timing. Compare like-for-like periods and consider order book timing when evaluating revenue fluctuations.
Recommended Investigation Thresholds for Manufacturing
| Account Category | Threshold % |
|---|---|
| Revenue | 5% |
| Cost of Goods Sold | 5% |
| Operating Expenses | 10% |
| Current Assets | 10% |
| Equity | 5% |
Regulatory note: Manufacturing entities with government contracts may have specific reporting requirements. Entities subject to environmental regulations should be assessed for potential provisions (IAS 37) that could affect analytical review expectations.
Worked Example: Manufacturing Analytical Review
A mid-size automotive parts manufacturer with overall materiality of €500,000 and performance materiality of €325,000. The 10% investigation threshold combined with the €325,000 absolute threshold creates the dual-flag system.
Overall materiality: €500,000 | Performance materiality: €325,000 | Threshold: 10%
| Account | PY | CY | Change | % |
|---|---|---|---|---|
| Revenue — Finished Goods | €23,500,000 | €25,000,000 | €1,500,000 | +6.4% |
| Raw Materials Consumed FLAG | €11,500,000 | €12,800,000 | €1,300,000 | +11.3% |
| Direct Labour | €4,050,000 | €4,200,000 | €150,000 | +3.7% |
| Production Overheads | €2,900,000 | €3,100,000 | €200,000 | +6.9% |
| Depreciation — Plant | €1,650,000 | €1,800,000 | €150,000 | +9.1% |
| Admin Expenses | €1,350,000 | €1,400,000 | €50,000 | +3.7% |
| Inventory — Raw Materials FLAG | €2,100,000 | €2,800,000 | €700,000 | +33.3% |
| Inventory — Finished Goods | €2,200,000 | €1,900,000 | €-300,000 | -13.6% |
| Trade Receivables | €3,800,000 | €4,100,000 | €300,000 | +7.9% |
| PP&E Net FLAG | €11,200,000 | €12,500,000 | €1,300,000 | +11.6% |
| Trade Payables FLAG | €2,700,000 | €3,200,000 | €500,000 | +18.5% |