Evaluating misstatements, opening balances and comparatives: ISA 450, ISA 510 and ISA 710

When the fieldwork is done, the auditor adds up what has gone wrong and decides whether the financial statements can still be called true and fair. This topic covers that final evaluation under International Standard on Auditing (ISA) 450. Two related checks that give the figures a starting point and a comparison: opening balances in a first audit under ISA 510, and comparative information under ISA 710.

The review stage ties the audit together. Examiners give a list of uncorrected errors and ask whether they are material, or describe a new client and ask what the auditor must do about last year’s figures. The method is the same each time: judge size and nature, add the errors up, and compare them with the levels set at planning.

The review stage of the audit

After testing controls and carrying out substantive work, the auditor reviews and evaluates the evidence gathered. The auditor backs up detailed testing of controls, transactions and balances with a broader review of other information and events that may affect the financial statements. Analytical procedures are used again here as a final check that the draft statements make sense.

Evaluating misstatements: ISA 450

At this stage the auditor makes an overall evaluation of the errors found. Errors in individual areas, such as receivables or inventory, are summarised and totalled. The total is compared with the materiality thresholds set at planning, which lets the auditor decide whether the statements are materially correct, one aspect of whether they show a true and fair view.

The auditor’s objective under ISA 450 Evaluation of misstatements identified during the audit is to evaluate the effect of identified misstatements on the audit and of uncorrected misstatements on the financial statements. A misstatement may concern the amount, classification, presentation or disclosure of an item.

What ISA 450 requires

1. Accumulate all misstatements found, unless they are clearly trivial.
2. Revise the plan if needed. If the total of misstatements identified approaches, or could approach, materiality, decide whether the overall audit strategy and audit plan need revising.
3. Communicate and ask for correction. Tell an appropriate level of management of all misstatements found and ask for them to be corrected.
4. If management refuses, obtain its reasons and take them into account when evaluating whether the financial statements as a whole are free from material misstatement.
5. Reassess materiality under ISA 320 before evaluating the effect of uncorrected misstatements.
6. Decide whether uncorrected misstatements are material, individually or added together, considering their size, nature and circumstances and the effect of any uncorrected misstatements from prior periods.
7. Communicate to those charged with governance the effect that uncorrected misstatements may have on the audit report.
8. Obtain a written representation from management that the effect of uncorrected misstatements is immaterial, individually and in total.
9. Document the amount below which misstatements are clearly trivial, all misstatements accumulated and whether they have been corrected, and the conclusion on whether uncorrected misstatements are material.

Background: ISA 450 describes three kinds of misstatement. Factual misstatements are those with no doubt, such as an arithmetic error. Judgemental misstatements arise from estimates or policies the auditor considers unreasonable. Projected misstatements are the auditor’s best estimate of misstatement in a population, found by projecting those found in a sample. “Clearly trivial” means clearly inconsequential, whether judged by size, nature or circumstance, and is a lower bar than immaterial.

It is not the same as a low materiality figure.

The syllabus notes that the review stage also includes other specific areas of evaluation, such as subsequent events and going concern, which are covered in the next topics.

Opening balances: ISA 510

Most companies must show comparative figures for the previous year. To conclude that the statements give a true and fair view, the auditor must be confident that:

• opening balances brought forward in the accounting records agree with the audited figures in the prior year statements;
• accounting policies have been applied consistently over the current and prior years; and
• classification and disclosure are consistent between the years.

Where the auditor audited the previous year and gave an unmodified opinion, this is easy. A different situation arises in a first audit. The new auditor cannot ignore the opening statement of financial position. Closing balances for the prior period appear as comparative figures, and an error in opening balances can affect the current period. For example, if opening inventory is overstated, cost of sales is also misstated, too high.

When ISA 510 applies

ISA 510 Initial audit engagements: opening balances applies where the prior period statements were not audited, or were audited by another auditor, the predecessor auditor.

The objective

The auditor aims to get sufficient appropriate evidence on whether:

1. opening balances contain misstatements that materially affect the current period’s statements; and
2. appropriate accounting policies in the opening balances have been consistently applied in the current period, or a change of policy has been properly accounted for and disclosed.

Required procedures

• Read the most recent financial statements and audit report, if any, for information relevant to opening balances.
• Check that the prior period’s closing balances have been correctly brought forward.
• Check that opening balances reflect appropriate accounting policies.

Then one or more of:

1. where the prior statements were audited, review the predecessor auditor’s working papers for evidence on opening balances;
2. consider whether procedures in the current period give evidence on some opening balances, for example cash received from customers in the period gives evidence that a receivable existed at the opening date; or
3. carry out specific procedures to get evidence on the opening balances.

If there is evidence that opening balances could contain material misstatements affecting the current period, the auditor performs additional procedures to assess the effect. If such misstatements exist, they are communicated to those charged with governance under ISA 450. The effect on the report is covered in the reporting topics.

Comparative information: ISA 710

ISA 710 Comparative information: corresponding figures and comparative financial statements applies to all external audits, while ISA 510 is concerned with new engagements and opening balances. It deals with audit work on corresponding amounts and other comparative information for the preceding period.

The audit work on comparatives is significantly less than on current year figures. It is normally limited to checking that comparatives have been:

• correctly reported as the framework requires; and
• appropriately classified.

ISA 710 therefore requires the auditor to evaluate whether:

1. the comparative information agrees with the previous period or, where appropriate, has been restated; and
2. accounting policies have been applied consistently in both periods or, if changed, the changes have been properly dealt with.

The auditor must also:

• perform additional procedures if aware of a possible material misstatement in the comparatives while carrying out the current audit; and
• obtain written representations covering all periods referred to in the opinion.

The work is simple if the auditor audited the previous year and reported that the statements gave a true and fair view. If the auditor did not, the guidance in ISA 510 applies as well. The audit opinion does not normally refer to the corresponding figures, except in particular circumstances covered in later topics.

Background: ISA 710 distinguishes corresponding figures, where the comparatives are part of the current period statements and are read with them, from comparative financial statements, where the prior period statements are presented in full and the auditor’s opinion refers to each period.

The rules in more depth

Why clearly trivial is not the same as immaterial

Materiality is the level at which an error could influence users. Clearly trivial is a much lower level, below which errors are so small that tracking them adds nothing. If there is doubt whether an item is trivial, it is not. The threshold keeps the schedule of misstatements to a useful size and no more.

Why uncorrected errors are added up

One small error is harmless. Ten small errors in the same direction can reduce profit by a material amount. Aggregation puts them together. The auditor also considers whether they are likely to be the tip of a larger problem, since an error found in a sample suggests more in the rest of the population.

Why materiality is reassessed first

Materiality is set early using draft figures. If actual profit differs from the draft, the original level may no longer suit. The auditor therefore revisits it before judging the uncorrected misstatements, so that the comparison is made against the right level.

Why opening balances matter

The closing position of the last year is the opening position of this one. A wrong opening inventory changes this year’s cost of sales and profit. A wrong opening receivable that is later collected or written off changes this year’s income. If the new auditor ignored them, errors from earlier years could pass into the audited figures.

Why comparatives get less work

They were audited, or should have been, in the previous period. The aim is only to make sure they are carried across and presented properly. The extra work arises when the auditor is new or when evidence of a problem appears.

Worked example: a schedule of misstatements and a new client

1. Accumulate. The petty cash error is below ₦1 million and clearly trivial, so it need not be accumulated. The other four are recorded.
2. Add up.
   Profit overstated by ₦8 million + ₦5 million + ₦4 million = ₦17 million.
   This is 85% of overall materiality of ₦20 million and about 9.4% of profit.
   The ₦2 million classification does not change profit but affects the statement of financial position.
3. Approaching materiality. The total is close to materiality, so the auditor decides whether the strategy and plan need revising, for example extending work on inventory and accruals.
4. Nature. All three profit errors go the same way, which suggests possible management bias. Overstated inventory and understated accruals are also areas where more errors may lie.
5. Reassess materiality, then conclude. If actual profit is lower than expected, materiality may need lowering, and then ₦17 million may exceed it. Management refused to correct, so obtain the reasons and weigh them. Tell those charged with governance the effect on the report, obtain a representation, and document.
6. Opening balances. Read the prior year statements and report, check closing balances were carried forward and policies match, and review the predecessor’s papers. Use current period evidence, for example receipts from customers for opening receivables and the count of inventory, which, with the roll-back of movements, gives evidence on opening inventory. Do specific procedures where this is not enough.

Conclusion. The uncorrected misstatements may be material in total. Press for correction, or consider a modified opinion if materiality is breached.

How to score full marks

• For ISA 450, follow the sequence: accumulate, revise plan, communicate, reasons, reassess materiality, decide, tell governance, representation, document.
• Do the arithmetic. Add the misstatements, compare with materiality and say the answer in a sentence.
• Say why the nature matters: same direction, management bias, effect on loss or profit, covenants.
• For opening balances, give the three general procedures and the three alternatives, with a worked example of each.
• For comparatives, say the work is limited to agreement, consistency and classification.
• Mention the clearly trivial threshold and that it is not materiality.
• Time. Spend time in proportion to marks.

Common mistakes in the exam

• Treating clearly trivial as the same as immaterial.
• Looking at each error alone and forgetting to add them up.
• Forgetting to reassess materiality before concluding.
• Forgetting the written representation and the communication to those charged with governance.
• Ignoring opening balances in a first audit.
• Treating comparatives as needing the same work as current figures.
• Saying the report should refer to comparatives in a normal case.

Quick revision

• Review stage: broader review plus final analytical procedures.
• ISA 450: accumulate (not clearly trivial), revise plan, communicate, reasons for refusal, reassess materiality, decide on materiality, tell governance, representation, document.
• Size, nature and circumstances. Prior period effects count.
• ISA 510: first audits. Read last statements and report; check brought forward; check policies; predecessor papers, current period evidence or specific procedures.
• ISA 710: comparatives agree or are restated; policies consistent; extra procedures if a misstatement is suspected; representations cover all periods.
• The opinion does not normally refer to comparatives.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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