45The auditor shall obtain an understanding of the measurement and review of the entity’s financial performance.

45 The auditor shall obtain an understanding of the measurement and review of the entity’s financial performance.

46 Performance measures and their review indicate to the auditor aspects of the entity’s performance that those charged with governance, management and others consider to be of importance. Performance measures, whether external or internal, create pressures on the entity that, in turn, may motivate management to take action to improve the business performance or to misstate the financial report. Obtaining an understanding of the entity’s performance measures assists the auditor in considering whether such pressures result in management actions that may have increased the risks of material misstatement.

47 Management’s measurement and review of the entity’s financial performance is to be distinguished from the monitoring of controls (discussed as a component of internal control in paragraphs 113-116), though their purposes may overlap. Monitoring of controls, however, is specifically concerned with the effective operation of internal control through consideration of information about the control. The measurement and review of performance is directed at whether business performance is meeting the objectives set by those charged with governance and management (or third parties), but in some cases performance indicators also provide information that enables management to identify deficiencies in internal control.

48 Internally-generated information used by management for this purpose may include key performance indicators (financial and non-financial), budgets, variance analysis, segment information and divisional, departmental or other level performance reports, and comparisons of an entity’s performance with that of competitors. 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 provide information useful to the auditor’s understanding of the entity and its environment. Such reports often are obtained from the entity being audited.

49 Internal measures may highlight unexpected results or trends requiring management’s enquiry of others in order 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 a risk of misstatement of related financial report information. 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 report.

50 Much of the information used in performance measurement may be produced by the entity’s information system. If management assumes that data used for reviewing the entity’s performance are accurate without having a basis for that assumption, errors may exist in the information, potentially leading management to incorrect conclusions about performance. When the auditor intends to make use of the performance measures for the purpose of the audit (for example, for analytical procedures), under paragraph 45 of this Auditing Standard, the auditor needs to consider whether: