ISA 450

Evaluation of Misstatements Identified during the Audit

1Objective and scope

ISA 450 deals with the auditor's responsibility to evaluate the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements. It applies the materiality set under ISA 320 to what the audit actually found and completes the loop into the opinion under ISA 700 and ISA 705. The auditor's conclusion on whether the financial statements are free from material misstatement depends on this evaluation: an audit that accumulates misstatements but never weighs them together, or that lets management leave 'immaterial' errors uncorrected without looking at the aggregate and the qualitative implications, has not reached a supportable opinion.

The objectives are to evaluate the effect of identified misstatements on the audit, and the effect of uncorrected misstatements, if any, on the financial statements.

2Key definitions

3Requirements

Accumulation and consideration during the audit

• Accumulate misstatements identified during the audit, other than those that are clearly trivial. The clearly trivial threshold is set at planning (a small fraction of overall materiality) and is not the same as immaterial: where there is any uncertainty about whether an item is clearly trivial, it is accumulated.
• Determine whether the overall audit strategy and audit plan need to be revised if the nature of identified misstatements and the circumstances of their occurrence indicate that other misstatements may exist that, aggregated with those accumulated, could be material, or if the aggregate of accumulated misstatements approaches materiality.
• If, at the auditor's request, management has examined a class of transactions, balance or disclosure and corrected the misstatements found, the auditor performs additional procedures to determine whether misstatements remain.

Communication and correction

The auditor communicates on a timely basis all misstatements accumulated during the audit with the appropriate level of management, unless prohibited by law or regulation, and requests management to correct them. Correcting all misstatements, including immaterial ones, is what keeps the accounting records accurate and reduces the risk that future periods are misstated by the cumulative effect. If management refuses to correct some or all, the auditor obtains an understanding of management's reasons and takes that understanding into account in evaluating whether the financial statements as a whole are free from material misstatement.

Evaluating the effect of uncorrected misstatements

• Before evaluating, reassess materiality under ISA 320 to confirm it remains appropriate in the context of the entity's actual financial results.
• Determine whether uncorrected misstatements are material, individually or in aggregate, considering the size and nature of the misstatements, both in relation to particular classes of transactions, balances or disclosures and to the financial statements as a whole, and the particular circumstances of their occurrence; and the effect of uncorrected misstatements related to prior periods on the relevant classes, balances or disclosures and on the financial statements as a whole.
• Circumstances that may make a misstatement material despite its size: it affects compliance with regulatory requirements, debt covenants or other contractual terms; it masks a change in earnings or other trends; it affects ratios used to evaluate financial position, results or cash flows; it affects segment information; it increases management compensation; it conceals an unlawful transaction; or it relates to items involving particular parties (related parties, management).
• Where an individual misstatement is judged material, it is unlikely to be offset by other misstatements; classification misstatements are evaluated for materiality even where the profit effect is nil.
• Prior-period uncorrected misstatements may be evaluated on either the 'iron curtain' (balance sheet) or the 'rollover' (income statement) approach; the auditor considers both effects so that a misstatement material on either basis is not overlooked.

4Documentation and reporting

• Document the amount below which misstatements are regarded as clearly trivial, all misstatements accumulated during the audit and whether they have been corrected, and the auditor's conclusion as to whether uncorrected misstatements are material, individually or in aggregate, and the basis for that conclusion.
• Communicate to those charged with governance the uncorrected misstatements and the effect they, individually or in aggregate, may have on the opinion, identifying material uncorrected misstatements individually, and request their correction; also communicate the effect of uncorrected misstatements related to prior periods.
• Request a written representation from management and, where appropriate, those charged with governance that they believe the effects of uncorrected misstatements are immaterial, individually and in aggregate, to the financial statements as a whole; a summary of the items is included in or attached to the representation (ISA 580).
• Uncorrected material misstatements lead to a qualified or adverse opinion under ISA 705, depending on whether the effect is pervasive.

5Examinable focus