Module – ISA 320-450-700 – Part II
Notes for Select Slides
Materiality, Misstatements, and Reporting – Part II
ISA 450, Evaluation of Misstatements Identified During the Audit
ISA Implementation Support Module
Notes for Select Slides
The following supporting notes accompany the PowerPoint slides for this module and do not amend or override the ISAs, the texts of which alone are authoritative. Reading these notes is not a substitute for reading the ISAs. The notes are not meant to be exhaustive and reference to the ISAs themselves should always be made. In conducting an audit in accordance with ISAs, the auditor is required to comply with all the ISAs that are relevant to the engagement.Slide 2 Notes
- Overview of Module
o Outcome of revision of ISA 320 was two separate ISAs for enhanced clarity:
§ A revised ISA 320 on determining and using materiality in planning and performing an audit.
§ A new ISA 450 on evaluating misstatements identified during the audit.
o The concept of materiality links ISAs 320, 450 and 700. It is applied in both planning and performing the audit; in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements; and in forming the opinion on the financial statements.
Slide 4 Notes
- Factual misstatements
o Misstatements about which there is no doubt.
- Judgmental misstatements
o Differences arising from subjective decisions made by management regarding accounting estimates that the auditor considers unreasonable, or the selection or application of accounting policies that the auditor considers inappropriate.
- Projected misstatements
o The auditor’s best estimate of misstatements in given populations through the projection of misstatements identified in samples.
- Clearly trivial misstatements are not considered in evaluation of identified misstatements
o Standard allows the auditor to set an amount below which misstatements would not need to be accumulated because the accumulation of such amounts clearly would not have a material effect on the financial statements.
o Important to note that “clearly trivial” does not mean “not material.”
o Matters that are clearly trivial are of a wholly different and smaller order of magnitude than materiality determined under ISA 320.
o These are matters that are clearly inconsequential, individually or in aggregate, when judged by any criteria of size, nature or circumstances.
o If there is any doubt as to whether a misstatement is clearly trivial, it is considered not clearly trivial.
Slide 5 Notes
- Accumulate misstatements other than those that are clearly trivial as audit progresses
o Accumulate all identified misstatements other than those that are clearly trivial without regard to whether they are factual, judgmental or projected misstatements.
§ The distinction amongst factual, judgmental or projected misstatements may nevertheless be useful when evaluating the effect of accumulated misstatements and when communicating misstatements to management and TCWG.
o IAASB rationale for requiring consideration of identified misstatements as the audit progresses vs. at the completion of field work
§ An identified misstatement may not be an isolated occurrence – the nature of an identified misstatement and the circumstances of its occurrence may indicate that other misstatements may exist, e.g. when inappropriate assumptions about measurement of a specific item have been widely applied by management.
§ If total accumulated misstatements come close to materiality determined under ISA 320, there may be a greater than acceptably low level of risk that possible undetected misstatements, when added to misstatements already accumulated, could exceed materiality.
o In either one of those two cases, determine whether overall audit strategy and audit plan need revision.
o Also, if at the auditor’s request, management has examined a class of transactions, account balances or disclosure and corrected identified misstatements (e.g., in an audit sample), perform additional audit procedures to determine whether there are any remaining misstatements.
Slide 6 Notes
- Communicate all misstatements accumulated during the audit on a timely basis to management
o Provided that such communication is not prohibited by law or regulation (for example, tipping-off provisions under laws regarding money laundering or proceeds from crime).
o Old standard only required the auditor to communicate a misstatement to management on a timely basis if it resulted from error.
o Enables management to:
§ Agree whether the items are indeed misstatements, even if individually or collectively immaterial.
§ Take appropriate action.
o Helps the auditor address any potential disagreements with management regarding the misstatements on a timelier basis.
- Request management to correct them
o Under old ISA, if there was an indication that uncorrected misstatements may be material, the auditor could either request management to adjust the financial statements or extend audit procedures to reduce audit risk.
o The requirement to request management to correct all identified misstatements:
§ Enables management to maintain accurate books and records.
§ Reduces the risks of material misstatement of future financial statements that may arise because of the cumulative effect of immaterial, uncorrected, prior-period misstatements.
- Take that understanding into account when evaluating whether financial statements are free from material misstatement
o Consider management’s reasons for not correcting misstatements when evaluating the qualitative aspects of the entity’s accounting practices (including whether management bias appears to be present) in forming the opinion on the financial statements.
- Communicate with TCWG uncorrected misstatements and their effect on the auditor’s opinion
o Provided that such communication is not prohibited by law or regulation (for example, tipping off provisions under laws regarding money laundering or proceeds from crime).
o Request that these uncorrected misstatements be corrected.
o The auditor may discuss with TCWG the reasons for, and implications of, a failure to correct misstatements, taking into account the size and nature of the misstatements in the light of the surrounding circumstances.
o Also communicate the effect of uncorrected misstatements of prior periods on the relevant classes of transactions, account balances or disclosures, and the financial statements as a whole.
Slide 7 Notes
- Before evaluation, reassess materiality levels for financial statements as a whole and specific amounts
o Important to bear in mind that materiality determined under ISA 320 is often based on estimated financial results at the planning stage, before actual results are known.
o It is therefore necessary to revise materiality based on actual results before undertaking any evaluation of uncorrected misstatements.
o However, significant revision to materiality may already have been carried out during the audit as required by ISA 320 if the auditor has become aware of information that would have led to a different amount or amounts to have been determined initially.
- Evaluate effect on financial statements, both individually and in aggregate
o While qualitative considerations are important when applying materiality in planning and performing the audit, these considerations take on greater prominence when evaluating the effect of uncorrected misstatements on the financial statements.
o The new standard makes clear that the nature of uncorrected misstatements and the particular circumstances of their occurrence are as important as their size in determining whether the misstatements, individually or in aggregate, are material.
o For example, circumstances that may affect the evaluation include how far the misstatements affect:
§ Compliance with regulatory requirements or debt covenants
§ Key ratios such as return on equity or gearing
§ Determination of management compensation and award of incentives
Slide 8 Notes
- Obtain written representation from management and, where appropriate, TCWG whether they believe effects of uncorrected misstatements are, individually and in aggregate, immaterial to financial statements as a whole
o In circumstances where management and, where appropriate, those charged with governance do not believe that certain uncorrected misstatements are misstatements, they may decide to include a statement of the reasons for why they believe so.
o The written representation does not relieve the auditor of the need to form a conclusion on the effect of the uncorrected misstatements.
Copyright © October 2010 by the International Federation of Accountants (IFAC). All rights reserved. Permission is granted to make copies of this work provided that such copies are for use in academic classrooms or for personal use and are not sold or disseminated and provided that each copy bears the following credit line: “Copyright October 2010 by the International Federation of Accountants (IFAC). All rights reserved. Used with permission of IFAC. Contact for permission to reproduce, store, or transmit this work.” Otherwise, written permission from IFAC is required to reproduce, store, or transmit, or to make other similar uses of, this work, except as permitted by law. Contact .
ISBN: 978-1-60815-077-9
5/5