Evaluation of misstatements identified during the audit

 

Before to form an opinion on client`s financial statements the auditor shall accumulate misstatements identified during the audit, other than those that are clearly trivial.

Сlearly trivial is the misstatement of a wholly different (smaller) order of magnitude, or of a wholly different nature than those that would be determined to be material.

The auditor is required to evaluate:

(a) The effect of identified misstatements on the audit; and

(b) The effect of uncorrected misstatements on the financial statements.

To evaluate the effect of identified misstatements on audit means that the auditor should highlight the reason of misstatement and its impact on the audit.

All identified misstatements could be divided into three groups to assist in evaluating the effect of accumulated misstatements:

·        Factual misstatements (are misstatements about which there is no doubt).

·        Judgmental misstatements (misstatements arising from management's judgement concerning accounting estimates or accounting policies).

·        Projected misstatements (the auditor’s best estimate of misstatements arisen from sample in populations).

The auditor must communicate all misstatements accumulated during the audit to the appropriate level of management.  Auditors request management to correct those misstatements.

 Communication of misstatements to the appropriate level of management is important because it helps management to assess whether the classes of transactions, account balances and disclosures are misstated and to take necessary actions.

If management refuses to correct some or all of the misstatements communicated by the auditor, the auditor must understand the reasons for not making the corrections and evaluate whether the financial statements as a whole are free from material misstatement.

Before to evaluate the effect of uncorrected misstatements, the auditor must reassess materiality determined during the planning stage to confirm whether it remains appropriate in the context of the entity’s actual financial results.

To evaluate the effect of uncorrected misstatements on the financial statements means that the auditor should determine whether uncorrected misstatements are material, individually or in aggregate. In making this determination, the auditor considers:

•  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
•  The effect of uncorrected misstatements connected with prior periods on the relevant classes of transactions, account balances or disclosures, and the financial statements as a whole.

But sometimes the circumstances related to some misstatements may cause the auditor to evaluate them as material.

Misstatement(s) in a qualitative disclosure in financial statements may be considered material. The determination of whether a misstatement(s) in a qualitative disclosure is material, in the context of the applicable financial reporting framework and the specific circumstances of the entity, is a matter that involves the exercise of professional judgment.

Examples where such misstatements may be material include:

● Inaccurate or incomplete descriptions of information about the objectives, policies, and processes for managing capital for entities with insurance and banking activities.

● The omission of information about the events or circumstances that have led to an impairment loss (e.g., a significant long-term decline in the demand for a metal or commodity) in an entity with mining operations.

● The incorrect description of an accounting policy relating to a significant item in the statement of financial position, the statement of comprehensive income, the statement of changes in equity or the statement of cash flows.

● The inadequate description of the sensitivity of an exchange rate in an entity that undertakes international trading activities

Circumstances that may affect the evaluation of the auditor include the situations when the misstatement:

·        Affects compliance with regulatory requirements.

·        Affects compliance with debt covenants.

·        Relates to the incorrect selection or application of an accounting policy that is likely to have a material effect on future periods’ financial statements.

·        Conceal a change in earnings or other trends.

·        Affects ratios used to evaluate the entity’s financial position.

·        Affects segment information presented in the financial statements

·        Has the effect of increasing management compensation.

·        Is an omission of information not specifically required by the applicable financial reporting framework but is important to the users’ understanding of the financial position, financial performance or cash flows of the entity.

·      Affects other information to be included in the entity’s annual report that may influence the economic decisions of the users of the financial statements.

 Uncorrected misstatements and the effect that they, individually or in aggregate, may have on the opinion in the auditor’s report to be communicated to those charged with governance. The auditor should request that uncorrected misstatements be corrected.

The auditor is required to request them to provide a written representation about uncorrected misstatements. A summary of such items must be included in or attached to the written representation. Obtaining this representation does not relieve the auditor of the need to form a conclusion on the effect of uncorrected misstatements.

The auditor must include in the audit documentation relating to evaluation of misstatements identified during the audit includes the following matters:

(a) The amount of clearly trivial misstatement determined by the auditor.

(b) All misstatements accumulated during the audit and whether they have been corrected (in the form of table of identified misstatements)

(c) The auditor’s conclusion as to whether uncorrected misstatements are material, individually or in aggregate, and the basis for that conclusion.

ISA 450