This article has been prompted by a report that first appeared in the Independent Regulatory Board for Auditors’ newsletter, IRBA News 58. That report noted that the IRBA had noted an increasing trend of deficiencies in the evaluation of uncorrected misstatements. In addition, the enforcement committee (ENCOM) has concluded on a number of matters in which the evaluation of uncorrected misstatements was a common challenge. In view of the ENCOM’s request that registered auditors be reminded of their responsibilities in terms of International Standards on Auditing, in this article Kumukakwashe Matambo CA(SA) of the IRBA’s Standards Department highlights some salient points regarding this topic and offers links to other resources
Audit quality is a fundamental and critical factor that applies to every aspect of the work of auditors. Audit quality is dependent on the respective roles of those responsible for systems of quality management within audit firms, other stakeholders, such as audit committees, investors, oversight bodies, company directors and financial accountants who are responsible for the integrity of financial information, and all these role players performing their functions with the necessary skill and diligence. Therefore, when a significant deficiency theme arises from firm-wide and assurance engagement file inspections that casts doubt on audit quality, we take it as an opportunity to remind ourselves of the basic tenets relating to the auditor’s evaluation of uncorrected misstatements.
International Standard on Auditing (ISA) 450, Evaluation of Misstatements Identified During the Audit, deals with the auditor’s responsibility to evaluate the effect of identified misstatements on the audit and uncorrected misstatements, if any, on the financial statements.1 A misstatement is defined as ‘a difference between the reported amount, classification, presentation or disclosure of a financial statement item and the amount, classification, presentation or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or fraud.’2 Uncorrected misstatements are misstatements that the auditor has accumulated during the audit and that have not been corrected.3 These are commonly referred to as unadjusted audit differences. The auditor is required to accumulate misstatements identified during the audit, other than those that are clearly trivial.4
When an engagement team does not perform an appropriate evaluation of uncorrected misstatements during the completion stage of the audit, that may result in an inappropriate opinion being expressed on the financial statements. To give some context, the following are important:
- The auditor is required to form an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.5
- To form that opinion, the auditor shall conclude as to whether the auditor has obtained reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. Among other matters, that conclusion should take into account the auditor’s conclusion, in accordance with ISA 450, whether uncorrected misstatements are material, individually or in aggregate 6.
- The auditor is required to evaluate whether the financial statements are prepared, in all material respects, in accordance with the requirements of the applicable financial reporting framework. This evaluation should include consideration of the qualitative aspects of the entity’s accounting practices, including indicators of possible bias in management’s judgements.7
- The concept of materiality is applied by the auditor both in planning and performing the audit and 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 in the auditor’s report.8
- When evaluating the effect on the financial statements of all uncorrected misstatements, the auditor considers not only the size but also the nature of uncorrected misstatements and the particular circumstances of their occurrence.9
- The auditor is required to determine whether uncorrected misstatements are material, individually or in aggregate. In making this determination, the auditor is required to consider:
o The size and nature of the misstatements, both in relation to particular classes of transactions, account balances or disclosures and the financial statements as a whole, and the particular circumstances of their occurrence,10 and
o The effect of uncorrected misstatements related to prior periods on the relevant classes of transactions, account balances or disclosures, and the financial statements as a whole.11
- The auditor is required to include in the audit documentation:
o All misstatements accumulated during the audit and whether they have been corrected,12 and
o The auditor’s conclusion as to whether uncorrected misstatements are material, individually or in aggregate, and the basis for that conclusion.13
- The auditor is required to prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand significant matters arising during the audit, the conclusions reached thereon and significant professional judgements made in reaching those conclusions, among other matters.14 If, in exceptional circumstances, the auditor judges it necessary to depart from a relevant requirement in an ISA, the auditor is required to document how the alternative audit procedures performed achieve the aim of that requirement, and the reasons for the departure.15
Our inspections have identified several instances across audit firms where the auditor performed an evaluation of uncorrected misstatements and identified them as material, individually and/or in aggregate and then accepted these misstatements as unadjusted audit differences without modifying the auditor’s opinion on the financial statements. This, however, is incorrect and has the potential to result in an incorrect opinion.
Furthermore, the inspection process has also identified a significant lack of documented audit evidence regarding the engagement team’s assessment (quantitative and qualitative) of the unadjusted audit differences and an inappropriate evaluation of the aggregate unadjusted audit misstatements, as required by the ISAs. It has been observed that in some instances there is no documented evidence that uncorrected misstatements were accumulated and assessed for the group, where the audit was an audit of group financial statements.
There were also cases where the engagement team did not identify and resolve inconsistencies between the unadjusted differences in the audit file and those included in the management representation letter.
As a reminder, if the nature of a misstatement is a classification error (that is, the misstatement occurred from an initial incorrect classification), then the misstatement should still be evaluated in terms of the requirements of the standards quoted above. ISA 450, paragraph A20, gives guidance on how these can be evaluated. Where a misstatement does not arise from an inappropriate classification, paragraph A20 of ISA 450 cannot be used as guidance in evaluating the misstatement. The auditor should document the judgements made and the factors considered in making the conclusions, as required by the standards.
Reminder: The fundamental principles of professional competence and due care and professional behaviour
The fundamental principle of professional competence and due care in the IRBA Code of Professional Conduct for Registered Auditors (IRBA Code) requires registered auditors to act diligently and in accordance with applicable technical and professional standards. The fundamental principle of professional behaviour requires them to comply with relevant laws and regulations and avoid any conduct that the registered auditor knows or should know might discredit the profession.
When assessing uncorrected misstatements, quantitative and qualitative factors are both of importance and need to be taken into consideration. The qualitative reasons need to be considered, in line with the principles of the ISAs, and so do the documentation requirements of the ISAs. If uncorrected misstatements exceed materiality (as set by the engagement team) but are not adjusted or dealt with in the auditor’s report, another experienced auditor could come to a different conclusion and not adjusting or dealing with the uncorrected misstatements appropriately would be against the requirements of the IRBA Code.
1 ISA 450, paragraph 1.
2 ISA 450, paragraph 4(a).
3 ISA 450, paragraph 4(b).
4 ISA 450, paragraphs 3 and 5.
5 ISA 700, Forming an Opinion and Reporting on Financial Statements, paragraph 10.
6 ISA 700, paragraph 11(b).
7 ISA 700, paragraph 12.
8 ISA 320, Materiality in Planning and Performing an Audit, paragraph 5.
9 ISA 320, paragraph 6.
10 ISA 450, paragraph 11(a).
11 ISA 450, paragraph 11(b).
12 ISA 450, paragraph 15(b).
13 ISA 450, paragraph 15.
14 ISA 230, Audit Documentation, paragraph 8.
15 ISA 230, paragraph 12.
- IRBA’s 2022 Public Inspections Report on Audit Quality.
- SAICA FAQ Question 9 – ISA 450, Evaluation of misstatements identified during the audit.
- Application paragraphs A14−25 in ISA 450.