Introduction: Definitions and Objectives
i. Objectives and Definitions
Inherent misstatement is defined as a misstatement of an amount or disclosure that is not in accordance with the applicable financial reporting framework, created by the difference between the amount, classification, presentation, or disclosure of that amount or disclosure in the financial statements, and the amount or disclosure that the auditors determine as being a fair presentation. This is particularly applicable when making judgments about estimates, for example, in a balance of provision which cannot be directly audited… as these will ultimately be judged on whether it’s a fair presentation.
The definitions of misstatements provided in ISA 450 are: Inherent misstatement and Omitted misstatement.
From this definition, we can derive several points. Firstly, it is aimed at identifying and assessing the risk of material misstatements. Not just material misstatements, but those caused by fraud and error. To do this at the financial statement level (taking the financial statements as a whole) and at relevant assertion levels (where an assertion is a statement that something exists or did not happen). This provides the basis for the auditor to draw conclusions about the acceptability of the risk of material misstatement, which will become important when evaluating misstatements.
The objective of ISA 450 is to identify and assess the risk of material misstatement, whether due to fraud or error, at the financial statement and the relevant assertion levels, thereby providing a basis for the auditor to make informed conclusions about the acceptability of the risk of material misstatement.
ii) Objective of ISA 450
The main aim of ISA 450 is to evaluate whether there is any material misstatement in the financial statements due to fraud or error, to assess the risk that the financial statements are materially misstated, and to design and perform audit procedures that are responsive to the assessed risks. The duty of the auditor is to evaluate whether there are any material misstatements due to fraud or error in the financial statements. This is particularly pertinent as a result of management override. In obtaining an understanding of the accounting and internal control systems, the auditor shall make inquiries of management and others within the entity as to the possibility of management override. If the auditor has identified a risk of material misstatement due to fraud, this may affect the reliability of the representation in the internal audit, necessitating a direct assessment of the risk at the assertion level and a decision to change the nature, timing, and extent of the auditor’s procedures, which is required by ISA 330.
iii) Definitions of Misstatement
When evaluating the effect of the identified misstatement, an auditor must consider: (a) Its effect on the financial statements (b) The effect of the misstatement or the possible of its effects on the relevant assertions (c) The implications of the corrected and uncorrected misstatements.
Materiality is also of concern when it comes to misstatements. An auditor must consider materiality both in planning when assessing the risk of material misstatements and during the evaluation of the effect of identified misstatements. Because even though the effect of a misstatement is not determinable until after a detailed investigation, the existence of a misstatement affects various factors and may have a compounding effect.
Misstatements can occur in two ways, either fraudulently or unintentionally. ISA 450 does not differentiate how misstatements are made, only that an auditor should assume that there is a risk of material misstatement due to fraud, and error, and shall perform procedures to identify any.
Misstatements are in the mind of each individual auditor. They are the error or omission identified, and the error or omission actually differs from auditor to auditor. However, ISA 450 does provide a definition of misstatements. They are defined as “In a relevant assertion – a difference between the amount, classification, presentation, or disclosure of that which is reported in financial statements and the amount, classification, presentation, or disclosure which is required for the assertion to be in accordance with the applicable financial reporting framework.” This definition is particularly beneficial to auditors because it identifies that misstatements occur when there is a difference between what is actually in the financial statements and what should be in the financial statements according to the applicable financial reporting framework.
