Categories of Factual Misstatements
It can be assumed that factual misstatements are straightforward to detect and evaluate, and that auditors are likely to evaluate them consistently. This is because the distinction between the audited information and the auditors’ understanding, which is needed to evaluate misstatements, only exists for objective data, rather than those judgments regarding subjective information such as future viability, which may also be recorded in the financial statements. As a result, judgmental and projected misstatements arise only for subjective judgments made by management or those charged with governance. A judgmental misstatement occurs when the information being audited contains a material misstatement due to the auditor’s conclusion differing from the information held by management. A projected misstatement occurs in circumstances where the auditor expects to find misstatements in the future when the evidence of their occurrence is found in an amount or
- Factual Misstatements
The effect of the misstatement on the decision would be if the user makes specific decisions based on the item at the time of generating the sales. The user may change the decision if they receive information about the amount and nature of the misstatement and the effect on the performance activities compared to the decision at the time of generating the statement. Because of these changed decisions, the user may want to obtain further information about the change and may ask the client to obtain assurance about the change in the specific item. Changing the decision may cause the user to check other users’ decisions, and the effect can lead to management making changes in the useful activities and the performance of the specific items. Repeating these activities can lead to an increase in the specific item. The user may obtain further information to continue the decision, such as obtaining a new contract for the performance of specific items, and reliance on the audit client could change the decisions of other users. All these decisions mean that specific items with misstatements can lead to changes in the trying to activities and with additional inquiries on the changing. The effect changes the decision make on the performance activities of changing decisions mean that specific items with misstatements are key points to be repeated. Because of its effects, the factual misstatements are important. Also, the treatment and evaluation of these are no different from the evaluation of the uncertainties with ICR and any differences.
Analysing misstatements in an audit engagement, there are two major types: factual misstatements and judgmental misstatements. Factual misstatements occur when there is a difference between the amount, classification, presentation, or disclosure of a reported financial statement item, which is different from the requirements of an acknowledged framework. This type of misstatement can cause problems for the auditors because they have to work hard to discover the error. Additionally, if an error is discovered, it might harm the auditor-client relationship because the client might think that auditors are too inquisitive or are trying to find fault with the client’s work. The effects of this finding may lead to extra costs for the client because the auditor might request a fee increase due to the understanding that the client’s records were inaccurate. This can lead to ongoing audits being reviewed, and the auditor may have to audit the same area again. Factual misstatements are areas where the auditor can decline to give an opinion, and if they are “material but not pervasive,” then the auditor will give a qualified opinion.
- Judgmental Misstatements
Judgmental misstatements result from the auditor’s different point of view with management of the subject being audited. The auditor may conclude, based on the evidence, that the amount or disclosure of the financial statement item is not appropriate when judged by the criteria. Because judgment is involved, there often is no definitive evidence that the auditor’s judgment is more appropriate than that of management. However, misstatements may occur if there is a significant difference of opinion between management and the auditor and the auditor is unable to agree with management on the appropriateness of the amount or the disclosure of the item. This type of misstatement often results in a situation where the auditor has concluded, based on the evidence, that the financial statement item should be recorded or disclosed in a different manner than management has done. Given the subjectivity of judgment concerning the amount and the disclosure of financial statement items, in defining judgmental misstatements, it is necessary to differentiate the situation where the auditor believes the financial statement item is not fairly stated and the situation where the auditor believes that an item is incorrect although not a departure from fairness. The former situation represents an error or omission misstatement because it is a failure to include in the financial statement an item required for it to be fairly stated. The latter situation represents a judgmental misstatement.
- Projected Misstatements
Projected misstatements are the “auditors’ best estimate of the misstatements in a given population.” They are the auditor’s accumulated misstatement findings, including known and likely misstatements, and which the auditors compare to the FS materiality level (ASA 320.A14). They can be seen as a ‘forecast’ of the misstatements in the financial report. An important feature of projected misstatements is that the auditor has to consider any sampling risk in drawing conclusions from the sample results and project misstatements identified, to the population from which the sample is drawn. This is for attributes sampling, where sampling risk is the risk of assessing control risk too high or too low, when the true deviation rate is not equal to the tolerable rate. The assessment of control risk will affect the level of detection risk, and therefore the level of substantive procedures such as sampling rate and sample size. A high assessment of control risk will lower detection risk and therefore higher substantive procedures, and vice versa. The projected misstatements not only comprise of the misstatements identified, but also an estimate of the likely misstatements in the population for the relevant items. The uncertainty factor in assessing sampling risk means that the auditors need an accurate reflection of the probability of each possible sample result, as this calculated probability is an important component for measuring the level of sampling risk in attributing an assessed level of control risk to a specific attribute. In more complex terms, the auditors would use an approximation methodology (the simplified form of calculating a change in probabilities based on altering an event), and change analysis, to find the change in probability of a specific attribute(s) with a given change in the financial report misstatement materiality level. This is based on the correlation between the misstatement and the assessed level of control risk. Because there is a higher risk of misstating an account with a high assessed level of control risk.
- Correction of Misstatements
The importance of correcting misstatements is another area where the literature is silent. The auditing literature implies that auditors should correct all misstatements. More specifically, SAS (AU 326.20) and AAS 13 (AUs 322.20) require the auditor to request management to adjust the financial statements for all identified misstatements. However, it is well known that materiality affects the auditor’s decisions about which misstatements to correct. Misstatements below a certain amount (both relative and absolute) are considered immaterial and are usually not corrected. The decision to correct factual misstatements is also influenced by the cost and effectiveness of obtaining the necessary evidence. Factual misstatements are usually caused by errors in gathering, calculating, or transcribing information. If the evidence required to demonstrate that the recorded account balance is correct is expensive and time consuming to obtain, the auditor may decide to correct the misstatement rather than incur the additional cost. The misstatement is usually corrected by obtaining an adjustment from the client. In some cases where the evidence is easily obtainable, the auditor may ask the client to make the adjustment with a clear explanation of why the recorded amount is incorrect.
- Correcting Factual Misstatements: ADVERTISEMENT • Path to CPA & CFE Image Infographics Video Certification Challenges Same School New Career Contribute Post Your knowledge of SOX and internal controls is essential. AICPA Resources on Sarbanes Oxley and CRISP publications are great references for financial reporting internal controls and the related audit procedures.
The most common type of misstatement corrected by management is a factual misstatement because it is the easiest to detect. But even factual misstatements are frequently not corrected by management. This occurs in two situations: first, where management believes changing the reported information might draw more attention to the matter than if it were left alone. For example, a change in the estimated lives of company assets could indicate to investors that previous depreciation provisions were inadequate. The second situation is where management has defined the matter differently to the auditors and believes them to be in error. An example would be where the auditors have misreported the location of an overseas branch, but the head office has a different view as to what constitutes the location of a branch and believes the report to be correct. Then a situation arises whether auditors correct misstatements discovered and discussed with management but not considered to be errors.
- Correcting Judgmental Misstatements: If a similar judgement led to a different decision made under different circumstances, it could be reasonable and there could be no misstatement. In such cases, the auditor will have to change his alternative decision. He should do so if he becomes aware of the circumstances that existed when the accounting decision was made or if he finds another decision that is more clearly supportable under the requirements of the relevant accounting standard. Here, the change of decision by the auditor results in no misstatement and thus no proposed adjustment to the financial statements.
Judgemental misstatements arise due to a difference of opinion between the auditor and the management regarding accounting principles, estimates, and the selection or application of accounting policies. The alternative accounting decision chosen by the auditor results in a “difference that matters” between the two and hence leads to misstatements in the current as well as future financial statements. It is important on the part of the auditor to understand and evaluate the judgement involved and the circumstances leading to the decision taken by the management.
- Correcting Projected Misstatements: The third type of misstatement is projected misstatement. This is the difference between the amount or disclosure that was reported and the amount or disclosure that should have been reported in the absence of the misstatement, provided that the amount or disclosure reported is not fairly stated. Projected misstatements can arise through application of a known misstatement in a larger population, extrapolation from an audit sample to a population, or in some cases of a likely change in reporting that does not occur until after the date of the auditor’s report. For factual misstatements, the correction of projected misstatements usually involves reversing the audit procedures that led to the misstatement. If during the course of an audit an error is discovered in the application of a misstatement from a prior year under audit and the misstatement is projected as having had the same effect in the current year, the corrective action will be a prior year adjustment.
