Pipara & Co LLP

Evaluation of Misstatements Identified during the Audit

Introduction

Scope of this SA
This Standard on Auditing (SA) deals with the auditor’s responsibility to evaluate the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements. SA 700 (Revised)1 deals with the auditor’s responsibility, in forming an opinion on the financial statements, to conclude whether reasonable assurance has been obtained about whether the financial statements as a whole are free from material misstatement. The auditor’s conclusion required by SA 700 (Revised) takes into account the auditor’s evaluation of uncorrected misstatements, if any, on the financial statements, in accordance with this SA. SA 3202 deals with the auditor’s responsibility to apply the concept of materiality appropriately in planning and performing an audit of financial statements.
Effective Date

This SA is effective for audits of financial statements for periods beginning on or after April 1, 2010.

Objective
  1. The objective of the auditor is to evaluate:
    1. The effect of identified misstatements on the audit; and
    2. The effect of uncorrected misstatements, if any, on the financial statements.
Definitions
  1. For purposes of the SAs, the following terms have the meanings attributed below:
    1. Misstatement – A difference between the amounts, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or fraud. (Ref: Para. A1)

When the auditor expresses an opinion on whether the financial statements give a true and fair view or are presented fairly, in all material

1 SA 700(Revised), “Forming an Opinion and Reporting on Financial Statements”, paragraphs 10- 11.

2 SA 320, “Materiality in Planning and Performing an Audit”.

Handbook of Auditing Pronouncements-I.A

respects, misstatements also include those adjustments of amounts, classifications, presentation, or disclosures that, in the auditor’s judgment, are necessary for the financial statements to give a true and fair view or present fairly, in all material respects.

Uncorrected misstatements – Misstatements that the auditor has accumulated during the audit and that have not been corrected.

Requirements
Accumulation of Identified Misstatements
  1. The auditor shall accumulate misstatements identified during the audit, other than those that are clearly trivial. (Ref: Para. A2-A3)
Consideration of Identified Misstatements as the Audit Progresses
  1. The auditor shall determine whether the overall audit strategy and audit plan need to be revised if:
    1. The nature of identified misstatements and the circumstances of their occurrence indicate that other misstatements may exist that, when aggregated with misstatements accumulated during the audit, could be material; or (Ref: Para. A4)
    2. The aggregate of misstatements accumulated during the audit approaches materiality determined in accordance with SA 320. (Ref: Para. A5)
  2. If, at the auditor’s request, management has examined a class of transactions, account balance or disclosure and corrected misstatements that were detected, the auditor shall perform additional audit procedures to determine whether misstatements remain. (Ref: Para. A6)
Communication and Correction of Misstatements
  1. The auditor shall communicate on a timely basis all misstatements accumulated during the audit with the appropriate level of management, unless prohibited by law or regulation3.The auditor shall request management to correct those misstatements.(Ref: Para. A7-A9)
  2. If management refuses to correct some or all of the misstatements communicated by the auditor, the auditor shall obtain an understanding of management’s reasons for not making the corrections and shall take that understanding into account when evaluating whether the financial statements as a whole are free from material misstatement. (Ref: Para. A 10)
Evaluating the Effect of Uncorrected Misstatements
  1. Prior to evaluating the effect of uncorrected misstatements, the auditor shall reassess materiality determined in accordance with SA 320 to confirm whether it remains appropriate in the context of the entity’s actual financial results. (Ref: Para. A11-A12)
  2. The auditor shall determine whether uncorrected misstatements are material, individually or in aggregate. In making this determination, the auditor shall consider:
    1. The size and nature of the misstatements, both in relation to particular classes of transactions, account balances or disclosures and the financial statements as a whole, and the particular circumstances of their occurrence; and (Ref: Para. A13-A17, A19-A20)
    2. The effect of uncorrected misstatements related to prior periods on the relevant classes of transactions, account balances or disclosures, and the financial statements as a whole. (Ref: Para. A18)

Communication with Those Charged with Governance

  1. The auditor shall communicate with those charged with governance4 uncorrected misstatements and the effect that they, individually or in aggregate, may have on the opinion in the auditor’s report, unless prohibited by law or regulation. The auditor’s communication shall identify material uncorrected misstatements individually. The auditor shall request that uncorrected misstatements be corrected. (Ref: Para. A21-A23)
  2. The auditor shall also communicate with those charged with governance the effect of uncorrected misstatements related to prior periods on the relevant classes of transactions, account balances or disclosures, and the financial statements as a whole.
Written Representations
  1. The auditor shall request a written representation from management and, where appropriate, those charged with governance whether they believe the4 In accordance with the paragraph 13 of SA 260(Revised), if this matter has been communicated with person(s) with management responsibilities, and those person(s) also have governance responsibilities, the matter need not be communicated again with those same person(s) in their governance role.

Handbook of Auditing Pronouncements-I.A

effects of uncorrected misstatements are immaterial, individually and in aggregate, to the financial statements as a whole. A summary of such items shall be included in or attached to the written representation. (Ref: Para. A24)

Documentation
  1. The audit documentation shall include: (Ref: Para. A25)
    1. The amount below which misstatements would be regarded as clearly trivial (paragraph 5);
    2. All misstatements accumulated during the audit and whether they have been corrected (paragraphs 5, 8 and 12); and
    3. The auditor’s conclusion as to whether uncorrected misstatements are material, individually or in aggregate, and the basis for that conclusion. (paragraph 11)
Application and Other Explanatory Material
Misstatements (Ref: Para. 4(a))

A1.  Misstatements may result from:

  1. An inaccuracy in gathering or processing data from which the financial statements are prepared;
  2. An omission of an amount or disclosure;
  3. An incorrect accounting estimate arising from overlooking, or clear misinterpretation of, facts; and
  4. Judgments of management concerning accounting estimates that the auditor considers unreasonable or the selection and application of accounting policies that the auditor considers inappropriate.

Examples of misstatements arising from fraud are provided in SA 240.5

Accumulation of Identified Misstatements (Ref: Para. 5)

A2. The auditor may designate an amount below which misstatements would be clearly trivial and would not need to be accumulated because the auditor expects that the accumulation of such amounts clearly would not have a material effect on the financial statements. “Clearly trivial” is not another expression for “not material”. Matters that are “clearly trivial” will be of a wholly different

5 SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements,” paragraphs A1-A6.

(smaller) order of magnitude than materiality determined in accordance with SA 320, and will be matters that are clearly inconsequential, whether taken individually or in aggregate and whether judged by any criteria of size, nature or circumstances. When there is any uncertainty about whether one or more items are clearly trivial, the matter is considered not to be clearly trivial.

A3. To assist the auditor in evaluating the effect of misstatements accumulated during the audit and in communicating misstatements to management and those charged with governance, it may be useful to distinguish between factual misstatements, judgmental misstatements and projected misstatements.

  • Factual misstatements are misstatements about which there is no doubt.
  • Judgmental misstatements are differences arising from the judgments of management concerning accounting estimates that the auditor considers unreasonable, or the selection or application of accounting policies that the auditor considers inappropriate.

Projected misstatements are the auditor’s best estimate of misstatements in populations, involving the projection of misstatements identified in audit samples to the entire populations from which the samples were drawn. Guidance on the determination of projected misstatements and evaluation of the results is set out in SA 5306.

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