| A36. | Management and others will measure and review those things they regard as important. Performance measures, whether external or internal, create pressures on the entity. These pressures, in turn, may motivate management to take action to improve the business performance or to misstate the financial statements. Accordingly, an understanding of the entity's performance measures assists the auditor in considering whether pressures to achieve performance targets may result in management actions that increase the risks of material misstatement, including those due to fraud. See ISA (UK and Ireland) 240 for requirements and guidance in relation to the risks of fraud. |
| A37. | The measurement and review of financial performance is not the same as the monitoring of controls (discussed as a component of internal control in paragraphs A98-A104), though their purposes may overlap: |
| The measurement and review of performance is directed at whether business performance is meeting the objectives set by management (or third parties). |
| Monitoring of controls is specifically concerned with the effective operation of internal control. |
| In some cases, however, performance indicators also provide information that enables management to identify deficiencies in internal control. |
| A38. | Examples of internally-generated information used by management for measuring and reviewing financial performance, and which the auditor may consider, include: |
| Key performance indicators (financial and non-financial) and key ratios, trends and operating statistics. |
| Period-on-period financial performance analyses. |
| Budgets, forecasts, variance analyses, segment information and divisional, departmental or other level performance reports. |
| Employee performance measures and incentive compensation policies. |
| Comparisons of an entity's performance with that of competitors. |
| A39. | External parties may also measure and review the entity's financial performance. For example, external information such as analysts' reports and credit rating agency reports may represent useful information for the auditor. Such reports can often be obtained from the entity being audited. |
| A40. | Internal measures may highlight unexpected results or trends requiring management to determine their cause and take corrective action (including, in some cases, the detection and correction of misstatements on a timely basis). Performance measures may also indicate to the auditor that risks of misstatement of related financial statement information do exist. For example, performance measures may indicate that the entity has unusually rapid growth or profitability when compared to that of other entities in the same industry. Such information, particularly if combined with other factors such as performance-based bonus or incentive remuneration, may indicate the potential risk of management bias in the preparation of the financial statements. |
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