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In-Depth Study Complete
HKSA 450 - Evaluation of Misstatements Identified (Condensed)
๐ PDF โ HKICPA Handbook Vol III
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| Section | Key Concept | Brief Description |
|---|---|---|
| Scope & Objective | Evaluate misstatements | Evaluate effect of identified misstatements on audit and uncorrected misstatements on financial statements |
| Definitions | Misstatement & Uncorrected Misstatements | Difference between reported and required amount/classification/presentation/disclosure; uncorrected = not corrected by management |
| Accumulation | Clearly trivial threshold | Accumulate all misstatements except those clearly trivial (wholly different order of magnitude, inconsequential) |
| Consideration as Audit Progresses | Revise strategy if needed | Revise if nature indicates other misstatements may exist or aggregate approaches materiality |
| Communication & Correction | Timely communication to management | Communicate all accumulated misstatements to appropriate management level; request correction |
| Evaluating Effect of Uncorrected Misstatements | Materiality assessment | Reassess materiality; consider size, nature, circumstances, prior period effects; qualitative factors |
| Governance Communication | Uncorrected misstatements to those charged with governance | Communicate uncorrected misstatements, identify material ones individually, request correction |
| Written Representations & Documentation | Representation and audit file | Request written representation that uncorrected misstatements are immaterial; document clearly trivial threshold, all accumulated misstatements, conclusion with basis |
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Scope & Objective
Scope of HKSA 450
HKSA 450 deals with the auditor's responsibility to evaluate the effect of:
- Identified misstatements on the audit
- Uncorrected misstatements, if any, on the financial statements
Works in conjunction with HKSA 700 (Revised) (forming an opinion) and HKSA 320 (materiality).
Key Relationship: The auditor's conclusion under HKSA 700 (Revised) takes into account the evaluation of uncorrected misstatements performed in accordance with HKSA 450.
Objective
| Component | Description |
|---|---|
| (a) | Evaluate effect of identified misstatements on the audit |
| (b) | Evaluate effect of uncorrected misstatements on the financial statements |
Effective Date
Effective for audits of financial statements for periods beginning on or after 15 December 2009.
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Definitions
Misstatement (Paragraph 4(a))
Definition: 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.
Key Characteristics:
- Can arise from error or fraud
- For fair presentation frameworks, also includes adjustments necessary for fair presentation in the auditor's judgment
Sources of Misstatements (Application Guidance A1)
| Source | Description |
|---|---|
| (a) Inaccuracy in gathering or processing data | Errors in data collection or processing |
| (b) Omission of amount or disclosure | Including inadequate or incomplete disclosures |
| (c) Incorrect accounting estimate | Arising from overlooking or clear misinterpretation of facts |
| (d) Unreasonable judgments | Management's judgments that the auditor considers unreasonable |
| (e) Inappropriate classification | Inappropriate classification, aggregation, or disaggregation |
| (f) Omission for fair presentation | Omission of a disclosure necessary for fair presentation beyond specifically required disclosures |
Uncorrected Misstatements (Paragraph 4(b))
Definition: Misstatements that the auditor has accumulated during the audit and that have not been corrected.
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Accumulation of Identified Misstatements
Requirement (Paragraph 5)
Requirement: The auditor shall accumulate misstatements identified during the audit, other than those that are clearly trivial.
"Clearly Trivial" Concept (Application Guidance A2-A4)
| Aspect | Explanation |
|---|---|
| Not synonymous with "not material" | "Clearly trivial" is a different concept from "not material" |
| Order of magnitude | Wholly different (smaller) order of magnitude than material items |
| Nature | Wholly different nature than material items |
| Inconsequential | Clearly inconsequential whether taken individually or in aggregate |
| Uncertainty rule | When there is any uncertainty about whether items are clearly trivial, the misstatement is considered not clearly trivial |
Types of Misstatements (A6)
| Type | Definition |
|---|---|
| Factual misstatements | Misstatements about which there is no doubt |
| Judgmental misstatements | Differences arising from management's judgments that the auditor considers unreasonable or inappropriate |
| Projected misstatements | Auditor's best estimate of misstatements in populations, involving projection of misstatements identified in audit samples to entire populations |
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Consideration of Identified Misstatements as the Audit Progresses
Requirement (Paragraph 6)
The auditor shall determine whether the overall audit strategy and audit plan need to be revised if:
| Condition | Explanation |
|---|---|
| (a) Nature and circumstances indicate other misstatements may exist | When the nature of identified misstatements and circumstances of their occurrence indicate that other misstatements may exist that, when aggregated with accumulated misstatements, could be material |
| (b) Aggregate approaches materiality | When the aggregate of misstatements accumulated during the audit approaches materiality determined in accordance with HKSA 320 |
Evidence That Other Misstatements May Exist (A7)
- Misstatement arose from a breakdown in internal control
- Misstatement arose from inappropriate assumptions or valuation methods that have been widely applied by the entity
Risk When Aggregate Approaches Materiality (A8): Greater than acceptably low level of risk that possible undetected misstatements, when taken with the aggregate of accumulated misstatements, could exceed materiality. Undetected misstatements could exist due to sampling risk and non-sampling risk.
Requirement (Paragraph 7)
If, at the auditor's request, management has examined a class of transactions, account balance, or disclosure and corrected misstatements that were detected, the auditor shall perform additional audit procedures to determine whether misstatements remain.
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Communication and Correction of Misstatements
Requirement (Paragraph 8)
Requirement: The auditor shall communicate, unless prohibited by law or regulation, on a timely basis all misstatements accumulated during the audit with the appropriate level of management. The auditor shall request management to correct those misstatements.
Importance of Timely Communication (A10)
- Enables management to evaluate whether classes of transactions, account balances, and disclosures are misstated
- Allows management to inform the auditor if it disagrees
- Allows management to take necessary action
Benefits of Correction (A12)
- Enables management to maintain accurate accounting books and records
- Reduces risks of material misstatement of future financial statements due to cumulative effect of immaterial uncorrected misstatements related to prior periods
Requirement (Paragraph 9)
If management refuses to correct some or all of the misstatements communicated by the auditor, the auditor shall:
- Obtain an understanding of management's reasons for not making the corrections
- Take that understanding into account when evaluating whether the financial statements as a whole are free from material misstatement
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Evaluating the Effect of Uncorrected Misstatements
Requirement (Paragraph 10)
Requirement: Prior to evaluating the effect of uncorrected misstatements, the auditor shall reassess materiality determined in accordance with HKSA 320 to confirm whether it remains appropriate in the context of the entity's actual financial results.
Requirement (Paragraph 11)
The auditor shall determine whether uncorrected misstatements are material, individually or in aggregate. In making this determination, the auditor shall consider:
| Consideration | Details |
|---|---|
| (a) Size and nature of misstatements | 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 |
| (b) Effect of prior period uncorrected misstatements | On relevant classes of transactions, account balances, or disclosures, and the financial statements as a whole |
Circumstances That May Cause Misstatements to Be Material Even Below Overall Materiality (A21)
| Circumstance | Description |
|---|---|
| Regulatory compliance | Affects compliance with regulatory requirements |
| Debt covenants | Affects compliance with debt covenants or other contractual requirements |
| Future period impact | Relates to incorrect selection/application of accounting policy with immaterial current effect but likely material future effect |
| Trend masking | Masks a change in earnings or other trends |
| Ratio impact | Affects ratios used to evaluate financial position, results of operations, or cash flows |
| Segment information | Affects segment information presented in financial statements |
| Management compensation | Has effect of increasing management compensation |
| Previous communications | Significant having regard to known previous communications to users |
| Related parties | Relates to items involving particular parties |
| Omission of important information | Omission of information not specifically required but important to users' understanding |
| Other information | Affects other information in annual report that may influence economic decisions of users |
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Communication with Those Charged with Governance & Written Representations
Requirement (Paragraph 12)
Requirement: The auditor shall communicate with those charged with governance:
- Uncorrected misstatements and the effect they may have on the opinion in the auditor's report (unless prohibited by law or regulation)
- Identify material uncorrected misstatements individually
- Request that uncorrected misstatements be corrected
Requirement (Paragraph 13)
The auditor shall also communicate with those charged with governance the effect of uncorrected misstatements related to prior periods on:
- Relevant classes of transactions, account balances, or disclosures
- The financial statements as a whole
Large Number of Immaterial Misstatements (A27)
Where there is a large number of individual immaterial uncorrected misstatements, the auditor may communicate:
- The number of uncorrected misstatements
- The overall monetary effect of uncorrected misstatements
Written Representations (Paragraph 14)
Requirement: The auditor shall request a written representation from management and, where appropriate, those charged with governance whether they believe the effects of uncorrected misstatements are immaterial, individually and in aggregate, to the financial statements as a whole. A summary of such items shall be included in or attached to the written representation.
Management Disagreement (A29)
Management may not believe certain uncorrected misstatements are misstatements. They may add words such as: "We do not agree that items โฆ and โฆ constitute misstatements because [description of reasons]". Obtaining this representation does not relieve the auditor of the need to form a conclusion on the effect of uncorrected misstatements.
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Documentation
Requirement (Paragraph 15)
Requirement: The auditor shall include in the audit documentation:
| Documentation Item | Related Paragraph |
|---|---|
| (a) The amount below which misstatements would be regarded as clearly trivial | Paragraph 5 |
| (b) All misstatements accumulated during the audit and whether they have been corrected | Paragraphs 5, 8, and 12 |
| (c) The auditor's conclusion as to whether uncorrected misstatements are material, individually or in aggregate, and the basis for that conclusion | Paragraph 11 |
Additional Documentation Considerations (A30)
The auditor's documentation of uncorrected misstatements may take into account:
- Consideration of the aggregate effect of uncorrected misstatements
- Evaluation of whether the materiality level or levels for particular classes of transactions, account balances, or disclosures have been exceeded
- Evaluation of the effect of uncorrected misstatements on key ratios or trends
- Evaluation of compliance with legal, regulatory, and contractual requirements (e.g., debt covenants)
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