Measurement and Review Of the Entity Financial Performance

generally accepted accounting standards also require auditors to obtain an understanding of the measurement and review of the entitiy's financial performance, including both internal and external measures. Such measures might include :

1. key ratios and operating statistics
2. key performance indicators
3. employee performance measures and incentive compensations plans
4. industry trends
5. the use of forecast, budgets, and variance analysis
6. analyst reports and credit rating reports

a company might use variety of financial and nonfinancial measures to monitor performance. Today, many companies measures the efficiency of the manufacturing process by comparing the quantity of raw material used to the quantity of finished goods, and material and labour variencies. In addition, it might monitor the effectiveness of the manufacturing process using quality control statistics or measures of the amount of rework required to meet standards. This informations is essential for developing a knowledgeable perspective about reported amounts for inventory and cost of sales.

Many performance measures, such as those described above, are produced by the entity's information system. If management asumes that data used for reviewing the entity's performance are accurate without having a basis of that assumption, error may exist in the information, potentially leading management (or the auditors using the same information) to incorrect conclusions about performance. If the auditors uses management's performance measures to form an audit conclusions(e.g., in performing analytical procedures), he or she should consider the realibility of the informations system that produced the measure and wether the measure is sufficienly precise to detect material misstatement.

management and auditors use performance measure informations in different ways. When reported measures differ from management's expectations, management may take corrective action to improve the entitys performance. For example, poor inventory turnover might cause a company to to offer more attractive pricing in order to sell inventory. However, the audtor should consider whether a deviations in performance measures might indicated a risk of mistatement in underlying financial informations. A decline in inventory turnover might mean the certain manufacturing cost are being capitalized as part of inventory rather than being expensed. Deviations from expected performance measures are critical when asessing in inherent risk associated with financial statement assertions.