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Definitions
A misstatement is the difference between the amount, 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.
When the auditor expresses an opinion on whether the accounts are presented fairly, in all material respects, misstatements also include those adjustments of amounts, classifications, presentation, or disclosures that, in the auditor’s judgement, are necessary for the accounts to be presented fairly, in all material respects.
Misstatements may be errors or fraud. The term 'error' refers to an unintentional misstatement in the financial statements. The term '[link title="fraud" link="%2Faware%2FGAP%2FPages%2FFraud.aspx" /]
' refers to an intentional act. Two types of intentional misstatements are relevant to the financial audit: misstatements resulting from fraudulent financial reporting and misstatements resulting from misappropriation of assets. If the auditor believes that a misstatement is, or may be, the result of fraud, the auditor should consider the implications in relation to other aspects of the audit.
When testing controls, an error is a control deviation and the total errors are expressed as a rate of deviation or frequency of deviation.
When performing substantive tests of details, an error is a misstatement of a monetary amount, and is expressed as an extrapolated (projected) rate of error.
Instructions
In all circumstances, the auditor should investigate the nature and cause of errors identified and their possible effect on the objective of the particular audit procedure and on other areas of the audit.
The auditor should [link title="communicate" link="%2Faware%2FGAP%2FPages%2FCommunication-in-audit.aspx" /]
and [link title="clear" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FExamination%2FClearing.aspx" /]
all misstatements accumulated during the audit to the appropriate level of management on a timely basis and ask management to correct them.
If management refuses to correct some or all of the misstatements communicated to it by the auditor, the auditor obtains an understanding of management’s reasons for not making the corrections and takes this into account when evaluating whether the accounts as a whole are free from material misstatement.
Nature of errors
Some errors may have a common feature, e.g. type of transaction, location, or time period. In such circumstances, the auditor may decide to identify those items in the population that possess the common feature, and extend audit procedures in that stratum.
In extremely rare circumstances, a misstatement may be an anomaly (i.e. demonstrably not representative of misstatements in the population). For a misstatement to be considered as an anomaly, the auditor should have a high degree of certainty that it is not representative of the population. The auditor obtains this certainty by performing additional audit procedures to obtain sufficient appropriate [link title="audit%20evidence" link="%2Faware%2FGAP%2FPages%2FAudit-evidence.aspx" /]
that the error does not affect the remainder of the population.
Causes of errors
Misstatements may result from:
- an inaccuracy in gathering or processing data from which the accounts are prepared;
- an omission of an amount or disclosure;
- an incorrect accounting estimate arising from overlooking or clear misinterpretation of facts; or
- management’s judgements concerning accounting estimates that the auditor considers unreasonable, or the selection and application of accounting policies that the auditor considers inappropriate.
Errors may result from management override of a control, in which case, the auditor should question the preliminary assessment of internal controls.
The consideration of the causes of errors can facilitate the drafting of clear and cost-effective [link title="recommendations" link="%2Faware%2FGAP%2FPages%2FRecommendations.aspx" /]
.
Types of errors
The auditor should accumulate misstatements identified during the audit, other than those that are clearly trivial. To assist the auditor in considering the effects of misstatements accumulated during the audit and in communicating them to management, it is useful to distinguish between:
- factual misstatements: misstatements about which there is no doubt;
- judgemental misstatements: differences arising from management’s judgements concerning accounting estimates that the auditor considers unreasonable, or the selection or application of accounting policies that the auditor considers inappropriate;
- projected misstatements: 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.
Evaluating tests results in general
Once the audit tests are performed, the auditor should review all errors identified and consider whether the audit evidence enables the auditor to reach an appropriate conclusion about the population for each audit test.
The auditor should evaluate, separately for misstatements, and control deviations, whether they are [link title="material" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FPlanning%2FMateriality.aspx" /]
, individually or in aggregate. The auditor cannot simply assume that a misstatement is an isolated occurrence. Evidence that other misstatements may exist include cases where the auditor establishes that a misstatement arose from a breakdown in internal control or from inappropriate assumptions or valuation methods that have been widely applied by the entity.
Three scenarios are possible with regard to the rate of deviation or projected rate of error resulting from the audit tests and interpretation thereof:
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The rate of deviation (tests of controls) or projected rate of error plus known error(s) (tests of details):
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Interpretation
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is below the materiality threshold set by the auditor.
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- the controls can thus be relied upon
- the assertions are deemed to have been satisfied
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is less than but close to the materiality threshold.
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- the auditor considers the persuasiveness of sample results in light of other audit procedures, and may obtain additional audit evidence
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exceeds the materiality threshold set by the auditor.
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- controls are assessed as not operating effectively
- the assertions are not satisfied, and thus there is a risk of material misstatement
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If the evaluation of sample results indicates that the assessment of the relevant characteristic of the population needs to be revised, the auditor may:
- request management to investigate identified errors and the potential for further errors, and to make any necessary adjustments; and/or
- modify the nature, timing and extent of further audit procedures. For example, for tests of controls, the auditor might extend the sample size, test an alternative control or modify related substantive procedures.
The auditor should also determine whether the [link title="task%20plan%20and%20audit%20programme" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FPlanning%2Ftask-plan-audit-programme.aspx" /]
need to be revised if the aggregate of misstatements accumulated during the audit approaches the materiality level(s). In such circumstances, there may be a greater than acceptably low level of risk that possible undetected misstatements, when taken with the aggregate of misstatements accumulated during the audit, could exceed the materiality level.
Undetected misstatements could possibly exist because of the presence of sampling risk or non-sampling risk.
It may be necessary for management to examine a class of transactions, account balance or disclosure to identify and correct misstatements therein. After management has examined a class of transactions, account balance or disclosure and corrected misstatements that were found, the auditor performs further audit procedures to re-evaluate the amount of misstatements.
Results of tests of controls
The concept of effectiveness of the operation of controls recognises that some errors may occur in the way controls are applied by the entity.
When considering the errors identified, the auditor should determine whether the tests of controls performed provide an appropriate basis for use as audit evidence, whether additional tests of controls are necessary, or whether the potential risks of misstatement need to be addressed using substantive procedures.
No explicit extrapolation of errors is necessary for [link title="tests%20of%20controls" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FExamination%2FTests-of-controls.aspx" /]
, since the sample rate of deviation is also the extrapolated rate of deviation for the population as a whole.
The auditor should evaluate the results of controls testing at the level of each individual key control in order to reach an overall assessment of the effectiveness of the ontrols. Evaluating the results of controls testing requires a high degree of professional judgement as they have an impact on the audit approach. An unexpectedly high sample error rate in the tests of controls may lead to an increase in the assessed risk of material misstatement, unless further audit evidence substantiating the initial assessment is obtained.
The auditor should also assess whether management has detected the errors and deviations and the response and remedial actions they have taken to address them.
The result of the evaluation of controls has three possible impacts:
- controls operated effectively, consistently and continuously during the period under review, which implies that the auditor can place reliance on controls and continues to apply the planned audit approach and its level of reliance on controls;
- weaknesses are noted in the effectiveness and continuity of the control but the overall system is not considered as unreliable. In this case, the auditor can only place reduced reliance on controls and the preliminary assessment of internal controls and the level of
[link title="control%20risk" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FPlanning%2FControl-risk.aspx" /]
should be revised;
- controls are unreliable, i.e. they have not operated as expected and/or they have not operated continuously during the period under review and/or they could not be tested. In such cases, a system-based approach cannot be applied and audit assurance should be obtained from substantive procedures. If necessary, the preliminary assessment of internal controls and the level of
[link title="control%20risk" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FPlanning%2FControl-risk.aspx" /]
should be revised.
Assessment of the performance of the internal controls must be corroborated by [link title="substantive%20testing" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FExamination%2FSubstantive-procedures.aspx" /]
.
Results of tests of details
Evaluating the overall results of [link title="tests%20of%20details" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FExamination%2FTests-of-details.aspx" /]
requires professional judgement, as the auditor should understand the nature and cause of the errors and consider both the quantitative aspects, as obtained above, and the qualitative aspects of misstatements in order to reach a conclusion as to whether the population tested is fairly stated.
Errors found should be accurately recorded, especially when testing a statistical [link title="sample" link="%2Faware%2FGAP%2FPages%2FCA-FA%2FPlanning%2FAudit-sampling.aspx" /]
, so that the audit results can be extrapolated.
The auditor analyse whether the error:
- is quantifiable, i.e. it has a direct and measurable financial impact on the amount of the item tested. The percentage error and the monetary value of the quantifiable error are calculated in relation to the recorded value of the transaction at the level concerned;
- is not quantifiable, i.e. the error is not related directly to the audited item, or because its effect is not measurable, in which case the whole amount of the item concerned is considered when determining the seriousness of the error;
- material by value (exceeding the materiality threshold), nature or context, based on the above;
- is an anomaly or is systematic.
Errors identified during supplementary work outside the scope of representative samples are to be considered as “known errors". These errors are only taken into account if they relate to transactions covered by the audit scope (audit population). They are not projected to the entire population, but are taken into consideration on the basis of the absolute amounts (de minimis threshold for reporting known errors is €10 000 ).
For tests of details, the auditor should extrapolate all monetary errors found in the sample to the population and consider the effect of the extrapolated error on the particular audit objective and on other areas of the audit.
For non-statistical samples, the auditor should make a judgement about the likely misstatement in the population.
The auditor projects the total error for the population to obtain a broad view of the scale of errors, and to compare this indicator of best estimate to the materiality threshold (tolerable error) set by ECA.
Tolerable error is the tolerable misstatement , and will be an amount less than the auditor’s materiality threshold used for the individual class of transactions or account balances being audited.
When a misstatement is considered an [link title="anomaly" link="%23Anomaly" /]
, it is considered not to be representative of misstatement in the population. Therefore, it may be excluded from projection. However, its effect, if uncorrected, still needs to be considered in addition to the projection of the non-anomalous misstatements.
Effect of uncorrected misstatements
Before evaluating the effect of uncorrected misstatements, the auditor should reassess the materiality level(s) used in planning and performing the audit to confirm whether it/they remain appropriate.
The auditor should evaluate whether uncorrected misstatements are material, individually or in aggregate. In making this evaluation, the auditor considers the size and nature of the misstatements, both in relation to particular classes of transactions, account balances and disclosures and the annual accounts as a whole, and the particular circumstances of their occurrence.
Before considering the aggregate effect of uncorrected misstatements, the auditor considers each misstatement separately to:
- evaluate its effect on the relevant classes of transactions, account balances or disclosures, including whether the materiality level for that particular class of transactions - account balance or disclosure, if any, has been exceeded;
- evaluate whether it is appropriate to offset misstatements. If an individual misstatement is judged to be material, it is unlikely that it can be offset by other misstatements;
- evaluate the financial statement effect of classification misstatements.
Determining whether a classification misstatement is material requires the use of professional judgement and the evaluation of qualitative considerations, e.g. the effect of the classification misstatement on (i) individual line items or sub-totals or (ii) key ratios.
The circumstances of some misstatements may cause the auditor to evaluate them as material, individually or when considered together with other misstatements accumulated during the audit, even if they are below the materiality level for the accounts as a whole (or for a particular class of transactions, account balance or disclosure, if any).
Examples of circumstances that may affect the evaluation include the extent to which the misstatement:
- affects compliance with regulatory requirements;
- relates to the incorrect selection or application of an accounting policy that has an immaterial effect on the current period’s financial statements but is likely to have a material effect on future periods’ financial statements;
- affects segment information presented in the financial statements;
- is significant in view of the auditor’s understanding of instances of known previous communications to users;
- concerns items involving related parties;
- is an omission of information not required by the applicable financial reporting framework but which, in the auditor's judgement, is important to the users’ understanding of the financial position, financial result or cash flows of the entity.
Evaluating the financial statements as a whole
The auditor should evaluate whether the financial statements as a whole are free of material misstatement. When making this evaluation, the auditor should consider both the results of the evaluation of the uncorrected misstatements and the qualitative aspects of the entity’s accounting practices.
When considering the qualitative aspects of the entity’s accounting practices, the auditor recognises that management makes a number of judgements about the amounts and disclosures in the financial statements. During the audit, the auditor should be alert for possible bias in management’s judgements. The auditor may conclude that the cumulative effect of a lack of neutrality, together with the effect of uncorrected misstatements, cause the financial statements as a whole to be materially misstated.
Indicators of a lack of neutrality that the auditor takes into account when evaluating whether the financial statements as a whole are materially misstated include the following:
- the selective correction of misstatements brought to management’s attention during the audit;
- possible management bias in the making of accounting estimates.
If the auditor concludes that, or is unable to conclude whether, the financial statements as a whole are materially misstated; the auditor should consider the effect thereof on the auditor's opinion.
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