Communication & Reporting to Those Charged with Governance
a) Communication with Those Charged with Governance
Communication with those charged with governance is an integral part of the audit process because it helps the auditors gain a better understanding of the client’s management assertions, assess fraud risk, and approach the audit. If the communication goes well, it can help the auditor gather all necessary information to be used in the audit process and increase the effectiveness of the evidence that has been gathered. Assessing how management and those charged with governance comprehend misstatements, their effect on the financial statements, and the possible impact on the audit findings is an important factor in deciding whether the misstatement is material. It is part of rectifying the client’s actions or decisions that contain risk and have a significant effect on the company. If the client or those charged with governance assess that the misstatement is still immaterial, it becomes a constraint for the auditor to obtain more evidence to convince them that the misstatement is material. If the evidence obtained by the auditor is already sufficient to support their assessment, the possible impact is changing the final audit opinion. This is referred to in ISA 705 paragraph 17. In cases where management has not corrected the misstatement and the auditor assesses it as material, the auditor should require management to make appropriate corrections. This action can be taken if the misstatement is a reversible error and there is still a chance to correct it. Changing the initial opinion if the auditor has already issued the report can be done by communicating the facts to management and satisfying the requirements of the report, but it is less effective compared to issuing an amended report. Usually, the last effort is to issue an emphasis of matter on the financial statements to draw the reader’s attention to a note in the financial statements, a matter affecting the financial statements, or even the financial statements as a whole, whichalready contain the corrected opinion.
b) Reporting Misstatements to Governance
When misstatements are identified, auditors must consider the implications and the appropriate course of action, which generally involves consulting with management. Where the misstatement is believed to be more than inconsequential, there is a requirement to report it to the appropriate level of management. The SAS’s use the terminology “senior management” and “those charged with governance,” so it is important to differentiate between the two. The requirement to report misstatements to those charged with governance has been in place for a number of years. However, it is recognized that since the introduction of the Combined Code, there has been some confusion as to who exactly those charged with governance are. SAS 610 defines them as the people with responsibility for supervising the strategic direction of the entity and those responsible for the entity’s financial reporting and disclosures. This could range from a board of directors to a single owner-managed company, and it is unlikely that in smaller entities reporting on misstatements directly to management constitutes a departure from this requirement. However, the report goes on to say that auditors should use their professional judgment to determine the appropriateness of the people charged with governance or others in the entity to whom they should report misstatements. This allows flexibility for the auditor to assess who is best placed to deal with the information provided the requirement to communicate with governance is not bypassed. Communication is considered to be an iterative process, and so it is not expected that all misstatements are to be reported at once, although it is suggested that what is and what is not considered to be a misstatement and the implications for the financial statements is done at the earliest possible time. The specific wording of the SASs is at the discretion of the auditor. The wording of the requirement for reporting misstatements on internal controls is effectively the same as for reporting it on the financial statement. This came with the recognition that the differentiation between control and financial statement misstatements is often blurred, and the existence of a control misstatement will often indicate that there is a related financial statement misstatement and hence an adverse SAS 400. Given that the circumstances and implications of a misstatement can vary considerably, the assessment of materiality and the related impact on the financial statements, it is expected that the appropriate action upon reporting a misstatement is to be agreed with the appropriate level of management and documented. This may range from an adjustment of the financial statements to disclosure, to in rare cases a decision that the implications are such that the entity cannot present a true and fair view and so the related implications for integrity and objectivity and the future of the audit engagement must be considered. Finally, it should be recognized that it is a common occurrence for management to disagree with the auditor’s assessment of a misstatement, and so SAS 620 states that the auditor should agree to the frequency and nature of communication on reported misstatements with management.
Providing Recommendations and Suggestions
The final step is providing a recommendation or alternative report, which is the most important thing. Because if the misstatement has already affected the opinion, it is better for the team to provide a report for alternative ways to repair the misstatement. It is very helpful for the next year’s audit. But each report must estimate the positive and negative effects. If the negative effects of the report are greater, then the report does not need to be applied. He concludes that if the recommendations above are well executed, it can minimize the debate between the auditor and management and increase the management’s awareness of its responsibility to the financial report.
Another thing that might be considered is when the misstatement is very material and might cause the report to not reflect the true condition, there might be an expectation from governance that the misstatement can be repaired. The same as above, Mr. Henny said that the repair (cut off) is every suggestion must be based on the evaluation.
An interview result with an auditor from Big 4, who has experience in reporting misstatements to governance, delivers the full determination that conditions need to be achieved. The interviewee notified that his team has a very serious matter when reporting misstatements to governance. Because although it does not affect the opinion, the client sometimes has a different opinion about whether the misstatement was material or not. And sometimes his team would have an argument with the management. So where are the countermeasures? He himself said that when finding misstatements, the team should evaluate the effect of the misstatement on the financial report, in accordance with ASA 260. Then, after that, they must inform the management about the misstatement that will be reported to governance, and the information must be clear and understandable. When the management has the same opinion about the misstatement, the team should provide clear examples and the effect of the misstatement. But due to efforts to ratify the global standard, he hopes that IAI and DSA have their own policy about reporting misstatements. It can help future auditors to report effectively.
As of the current reporting, misstatements to governance isone of the audit reputation threats that auditors must face when they find and evaluate misstatements. By following ASA 260, the auditor must report to governance that the misstatement can be a threat to the materiality level. In this case, the auditor must provide its reports to governance, including the effect of the misstatement found and the evaluation of the misstatement, whether it affects single or pervasively on the financial report.
