IFAC



Materiality, Misstatements, and Reporting – Part II

ISA 450, Evaluation of Misstatements Identified During the Audit

ISA Implementation Support Module

Notes for Select Slides

|The following supporting notes accompany the PowerPoint slides for this module and do not amend or override the ISAs, the texts of which alone|

|are authoritative. Reading these notes is not a substitute for reading the ISAs. The notes are not meant to be exhaustive and reference to the|

|ISAs themselves should always be made. In conducting an audit in accordance with ISAs, the auditor is required to comply with all the ISAs |

|that are relevant to the engagement. |

|Slide 2 Notes |

|Overview of Module |

|Outcome of revision of ISA 320 was two separate ISAs for enhanced clarity: |

|A revised ISA 320 on determining and using materiality in planning and performing an audit. |

|A new ISA 450 on evaluating misstatements identified during the audit. |

|The concept of materiality links ISAs 320, 450 and 700. It is applied in both planning and performing the audit; in evaluating the effect of |

|identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements; and in forming the opinion on the|

|financial statements. |

|Slide 4 Notes |

|Factual misstatements |

|Misstatements about which there is no doubt. |

|Judgmental misstatements |

|Differences arising from subjective decisions made by management regarding accounting estimates that the auditor considers unreasonable, or |

|the selection or application of accounting policies that the auditor considers inappropriate. |

|Projected misstatements |

|The auditor’s best estimate of misstatements in given populations through the projection of misstatements identified in samples. |

|Clearly trivial misstatements are not considered in evaluation of identified misstatements |

|Standard allows the auditor to set an amount below which misstatements would not need to be accumulated because the accumulation of such |

|amounts clearly would not have a material effect on the financial statements. |

|Important to note that “clearly trivial” does not mean “not material.” |

|Matters that are clearly trivial are of a wholly different and smaller order of magnitude than materiality determined under ISA 320. |

|These are matters that are clearly inconsequential, individually or in aggregate, when judged by any criteria of size, nature or |

|circumstances. |

|If there is any doubt as to whether a misstatement is clearly trivial, it is considered not clearly trivial. |

|Slide 5 Notes |

|Accumulate misstatements other than those that are clearly trivial as audit progresses |

|Accumulate all identified misstatements other than those that are clearly trivial without regard to whether they are factual, judgmental or |

|projected misstatements. |

|The distinction amongst factual, judgmental or projected misstatements may nevertheless be useful when evaluating the effect of accumulated |

|misstatements and when communicating misstatements to management and TCWG. |

|IAASB rationale for requiring consideration of identified misstatements as the audit progresses vs. at the completion of field work |

|An identified misstatement may not be an isolated occurrence – the nature of an identified misstatement and the circumstances of its |

|occurrence may indicate that other misstatements may exist, e.g. when inappropriate assumptions about measurement of a specific item have been|

|widely applied by management. |

|If total accumulated misstatements come close to materiality determined under ISA 320, there may be a greater than acceptably low level of |

|risk that possible undetected misstatements, when added to misstatements already accumulated, could exceed materiality. |

|In either one of those two cases, determine whether overall audit strategy and audit plan need revision. |

|Also, if at the auditor’s request, management has examined a class of transactions, account balances or disclosure and corrected identified |

|misstatements (e.g., in an audit sample), perform additional audit procedures to determine whether there are any remaining misstatements. |

|Slide 6 Notes |

|Communicate all misstatements accumulated during the audit on a timely basis to management |

|Provided that such communication is not prohibited by law or regulation (for example, tipping-off provisions under laws regarding money |

|laundering or proceeds from crime). |

|Old standard only required the auditor to communicate a misstatement to management on a timely basis if it resulted from error. |

|Enables management to: |

|Agree whether the items are indeed misstatements, even if individually or collectively immaterial. |

|Take appropriate action. |

|Helps the auditor address any potential disagreements with management regarding the misstatements on a timelier basis. |

|Request management to correct them |

|Under old ISA, if there was an indication that uncorrected misstatements may be material, the auditor could either request management to |

|adjust the financial statements or extend audit procedures to reduce audit risk. |

|The requirement to request management to correct all identified misstatements: |

|Enables management to maintain accurate books and records. |

|Reduces the risks of material misstatement of future financial statements that may arise because of the cumulative effect of immaterial, |

|uncorrected, prior-period misstatements. |

|Take that understanding into account when evaluating whether financial statements are free from material misstatement |

|Consider management’s reasons for not correcting misstatements when evaluating the qualitative aspects of the entity’s accounting practices |

|(including whether management bias appears to be present) in forming the opinion on the financial statements. |

|Communicate with TCWG uncorrected misstatements and their effect on the auditor’s opinion |

|Provided that such communication is not prohibited by law or regulation (for example, tipping off provisions under laws regarding money |

|laundering or proceeds from crime). |

|Request that these uncorrected misstatements be corrected. |

|The auditor may discuss with TCWG the reasons for, and implications of, a failure to correct misstatements, taking into account the size and |

|nature of the misstatements in the light of the surrounding circumstances. |

|Also communicate the effect of uncorrected misstatements of prior periods on the relevant classes of transactions, account balances or |

|disclosures, and the financial statements as a whole. |

|Slide 7 Notes |

|Before evaluation, reassess materiality levels for financial statements as a whole and specific amounts |

|Important to bear in mind that materiality determined under ISA 320 is often based on estimated financial results at the planning stage, |

|before actual results are known. |

|It is therefore necessary to revise materiality based on actual results before undertaking any evaluation of uncorrected misstatements. |

|However, significant revision to materiality may already have been carried out during the audit as required by ISA 320 if the auditor has |

|become aware of information that would have led to a different amount or amounts to have been determined initially. |

|Evaluate effect on financial statements, both individually and in aggregate |

|While qualitative considerations are important when applying materiality in planning and performing the audit, these considerations take on |

|greater prominence when evaluating the effect of uncorrected misstatements on the financial statements. |

|The new standard makes clear that the nature of uncorrected misstatements and the particular circumstances of their occurrence are as |

|important as their size in determining whether the misstatements, individually or in aggregate, are material. |

|For example, circumstances that may affect the evaluation include how far the misstatements affect: |

|Compliance with regulatory requirements or debt covenants |

|Key ratios such as return on equity or gearing |

|Determination of management compensation and award of incentives |

|Slide 8 Notes |

|Obtain written representation from management and, where appropriate, TCWG whether they believe effects of uncorrected misstatements are, |

|individually and in aggregate, immaterial to financial statements as a whole |

|In circumstances where management and, where appropriate, those charged with governance do not believe that certain uncorrected misstatements |

|are misstatements, they may decide to include a statement of the reasons for why they believe so. |

|The written representation does not relieve the auditor of the need to form a conclusion on the effect of the uncorrected misstatements. |

|Copyright © October 2010 by the International Federation of Accountants (IFAC). All rights reserved. Permission is granted to make copies of |

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|ISBN: 978-1-60815-077-9 |

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