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
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.
- 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.
- 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.
- 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.om 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.
