810

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810
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2011-01-01 18:33:00
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Summarization Evaluation
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810
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  1. 810.1 One of the final steps near completion of the engagement is evaluation of the misstatements discovered in fieldwork.
    • SAS No. 99, (AU 316.75), Consideration of Fraud in a Financial Statement Audit requires that audit differences be evaluated as to whether they are indicative of possible fraud. SAS No. 107, Audit Risk and Materiality in Conducting an Audit (AU 312),
    • requires that the individual and combined effects of all uncorrected
    • misstatements (both known and likely) be considered to determine whether
    • they are material to the financial statements taken as a whole. To
    • evaluate the combined effect of various uncorrected misstatements, it is
    • necessary to summarize them in one place in the workpapers.
  2. Categories for Evaluation

    810.2 The categories of
    misstatements and the format used to summarize them are matters of
    individual firm preference. The authors use the following
    classifications in this Guide:
    • a. Normal Closing Entries. 10
    • These are routine entries, such as adjustments of accruals, that are
    • made to help the client close out the books for the year. If normal
    • closing entries are booked, they are not misstatements and should
    • not be included in the summary of audit differences. The authors also
    • believe that normal closing entries ordinarily are not significant
    • findings or issues that would be subject to the documentation
    • requirements of SAS No. 103, Audit Documentation (AU 339). Normally, the entries are prepared in each audit area as the fieldwork for a financial statement component is completed. HOA-CX-12.1
    • provides a “Closing Entry and Audit Adjustment Form” that can be used
    • to accumulate normal closing entries during the audit. However, it is
    • often useful to group all those entries in one place. Grouping closing
    • entries in one schedule is more convenient for supervisory review and
    • discussion with the client. The client must agree with booking these
    • entries and accept responsibility for them because the financial
    • statements are the client's responsibility.

    • b. Audit Differences. 11
    • These are any differences noted between the accounting records and
    • the evidence obtained during the audit, other than closing entries. An
    • audit difference could be any of the following:td dl { margin-top: 0px; margin-bottom: 0px; }

    (1) Passed adjustment for a specifically identified misstatement.

    (2) Projected misstatement from a substantive audit sampling application, such as from HOA-CX-8.2.

    (3) Significant unexplained difference from an analytical procedure that is treated like a misstatement.

    • (4)
    • Difference between the client's accounting estimate and the relevant
    • end of the auditor's acceptable range for that estimate, as discussed
    • beginning in paragraph 810.10.
  3. Audit Differences

    810.3 In discussing summarization and evaluation, the authors use the term audit differences to refer to misstatements of amounts and classification.
    • This term was adopted because, as a
    • practical matter, the auditor can only summarize quantitative
    • misstatements. Other misstatements, primarily those relating to
    • presentation and disclosure assertions, are usually judged qualitatively
    • on an individual basis.
  4. 810.4 Known and Likely Misstatements
    In analyzing audit differences, a distinction is drawn between known
    and likely misstatements. These terms are defined in SAS No. 107 (AU 312.08) as follows:
    • a. Known Misstatement. A specific misstatement that the
    • auditor identifies by performing audit procedures. A known misstatement
    • arises from the incorrect selection or misapplication of accounting
    • principles or misstatements of facts identified.


    • b. Likely Misstatement.
    • Misstatements that (1) arise from differences between judgments made
    • by management and the auditor about accounting estimates that the
    • auditor believes are unreasonable or inappropriate, and (2) the auditor
    • deems likely to exist resulting from an extrapolation from audit
    • evidence obtained.
  5. 810.5 Communication of Misstatements to Management SAS No. 107 (AU 312.42)
    requires the auditor to communicate to management on a timely basis all
    known and likely misstatements identified during the audit, other than
    trivial ones (trivial is defined in paragraph 810.8).
    SAS No. 107 (AU 312.44) requires the
    communication to distinguish between known and likely misstatements. SAS
    No. 107 also requires the auditor to ask management to do the following
    with respect to misstatements the auditor has identified:
    • • Correct all known misstatements, other than trivial ones.•
    • Examine the account balance, transaction class, or disclosure in which
    • the auditor identified a material likely misstatement from a sample to
    • identify and correct misstatements in the account balance, transaction
    • class, or disclosure.• When the auditor has identified
    • a likely misstatement involving a difference in an estimate, SAS No.
    • 107 states that the auditor should ask management to review the
    • assumptions and methods used in developing its (management's) estimate.
    • After management has reviewed and challenged the assumptions and
    • methods, the auditor should reevaluate the amount of likely misstatement
    • and, if necessary, perform further audit procedures.
  6. If management decides not to correct some or all of the known or likely misstatements, the auditor should
    • obtain an understanding of management's reasons for not correcting the
    • misstatements and take that into account when making the qualitative
    • considerations discussed in paragraph 810.13. The auditor should also consider the implications for the audit report. In addition, as discussed in section 812,
    • uncorrected misstatements are significant audit findings under SAS No.
    • 114 and should be communicated to those charged with governance.
  7. Evaluating Audit Differences

    810.6 SAS No. 107 (AU 312.62)
    states that the auditor must evaluate whether the financial statements
    taken as a whole are free of material misstatement. The auditor must
    consider both the individual and aggregate effects of all uncorrected
    misstatements (known and likely) to evaluate whether the financial
    statements are fairly stated. In making that evaluation, the auditor
    should consider both quantitative and qualitative factors. The
    summarization and evaluation of audit differences can be complex. It
    should include consideration of the following factors:
    • Nature. For example, services provided but not billed, accounts payable not recorded, and assets expensed instead of capitalized.

    • • Cause.
    • For example, arithmetic or mechanical mistake, or inappropriate
    • application of an accounting principle because of misunderstanding,
    • intentional use of an accounting principle that is not generally
    • accepted, and whether misstatements are isolated or related to a common
    • cause.

    • Amount. The dollar amount of the difference and whether the difference is an overstatement or understatement.

    • • Effect.
    • The financial statement components affected by the difference, (for
    • example, the excess of revenue over expenses or total liabilities).
    • (Also, consider the effect on compliance with loan covenants, such as
    • maintaining certain operating ratios, or similar issues.
  8. 810.7 According to SAS No. 107 (AU 312.51),
    misstatements should be combined in a way that enables the auditor to
    consider whether, in relation to individual amounts, subtotals, or
    totals in the financial statements, the misstatements materially
    misstate the financial statements taken as a whole
    • That simply means the auditor needs to consider not only the materiality
    • of individual misstatements, but also their combined effect on
    • important financial statement totals or subtotals.
  9. 810.8 Trivial Misstatements
    Some auditors set an amount below which detected misstatements need
    not be accumulated on the summary of audit differences (often referred
    to as adjustments passed at the workpaper level)
    • SAS No. 107 (AU 312.42)
    • requires the auditor to accumulate all known and likely misstatements
    • identified during the audit, except for those the auditor believes are
    • trivial. Footnote 17 to AU 312.42 states
    • that “trivial” matters “are amounts designated by the auditor below
    • which misstatements need not be accumulated. This amount is set so that
    • any such misstatements either individually or when aggregated with other
    • such misstatements, would not be material to the financial statements,
    • after the possibility of further undetected misstatements is
    • considered.” HOA-CX-2 provides a place for auditors to document the amount of misstatements that will be passed at the workpaper level.
  10. 810.9 When determining whether the
    amount of a misstatement is below the amount that should be accumulated
    on the summary of audit differences, the auditor should be careful not
    to net proposed adjustments at the workpaper level.
    • For example, assume the auditor has
    • determined that only misstatements greater than $500 need to be
    • accumulated on the summary of audit differences. If the auditor has a
    • known misstatement that overstates income by $10,000 and a likely
    • misstatement that understates income by $10,500, both misstatements
    • should be included on the summary of audit differences
  11. 810.10 Evaluating Estimates Section 802
    includes a discussion of accounting estimates and examples of common
    accounting estimates. The usual result of auditing an accounting
    estimate is a range for the estimate that the auditor considers
    reasonable.
    • If the client's estimate falls within this range, it is acceptable. If
    • it falls outside the range, then the difference between the client's
    • estimate and the closest end of the auditor's range should be considered
    • a likely misstatement and summarized with other audit differences. SAS
    • No. 107 states that an accounting estimate may be evaluated by comparing
    • it with a range or a point estimate, if the point is a better estimate
    • than any other amount. However, accounting estimates are usually
    • evaluated based on a range of reasonableness because it is rarely
    • possible to be precise in estimating future events.
  12. 810.11 SAS No. 107 also states
    that an auditor should consider whether differences between estimates
    best supported by the audit evidence, and the estimates included in the
    financial statements that are individually reasonable, indicate (in the
    aggregate) a possible bias on the part of management. If management, for
    example, always chooses estimated amounts for the valuation of assets
    that are at the low end of the range the auditor considers reasonable,
    the combined effect could result in a material misstatement of income.
    • In that case, the auditor should
    • consider whether other recorded estimates reflect a similar bias and
    • perform additional procedures to address those estimates. The auditor
    • should also consider whether management's estimates were at one end of
    • the auditor's reasonable range in the prior year and at the other end in
    • the current year. That could indicate the possibility that management
    • is using accounting estimates to manage the excess of revenues over
    • expenses. If the auditor believes that is the case, he or she should
    • consider communicating the matter to those charged with governance as
    • discussed in section 812.
  13. 810.12 SAS No. 99 (AU 316) requires the auditor to review accounting estimates for biases that could result in material misstatement due to fraud.
    • In addition, it requires auditors to perform a retrospective review of
    • significant prior-year accounting estimates to determine whether the
    • underlying judgments and assumptions indicate possible bias. The review
    • may provide additional information about whether the current year's
    • estimates could be biased. If the auditor identifies possible bias, the
    • auditor should evaluate whether the circumstances represent a risk of
    • material misstatement due to fraud.
  14. 810.13 Different Levels for Different Amounts, Subtotals, or Totals
    For planning purposes, a judgment is made about a single materiality
    amount for the financial statements taken as a whole. (As discussed in
    Chapter 6,
    however, the auditor may determine more than one level of planning
    materiality for particular items in the financial statements if there
    are items for which a lesser amount is more appropriate.)
    • However, in evaluation, an auditor is considering the effect of
    • misstatements on specific amounts, subtotals, or totals in financial
    • statements. In this case, it is possible to use a larger amount in
    • evaluating the effect on certain amounts, subtotals, or totals than on
    • others. The “Audit Difference Evaluation Form” at HOA-CX-12.2
    • is designed to accumulate audit differences by various financial
    • statement subtotals to accommodate the auditor's consideration of the
    • effect of misstatements noted. However, exclusive reliance on a
    • quantitative amount or percentage relationship for determining
    • materiality is not appropriate. Qualitative factors also should be
    • considered. Qualitative considerations are summarized on HOA-CX-12.2.
    • If, as the audit progresses or when evaluating audit findings, the
    • auditor concludes that a lower materiality level than the amount
    • determined during audit planning is appropriate, the auditor should
    • reconsider the related levels of tolerable misstatement and the
    • sufficiency of the further audit procedures that were performed. If the
    • auditor believes a misstatement is, or may be, the result of fraud, the
    • auditor should consider the implications of the misstatement in relation
    • to other aspects of the audit, as described in SAS No. 99, even if the
    • effect of the misstatement is not material to the financial statements
  15. 810.14 Overall Evaluation
    If the auditor believes the financial statements are materially
    misstated, the auditor should request that management make the necessary
    corrections. If management refuses, the auditor must determine the
    implication for the auditor's report.
    • 810.15 Even if the auditor
    • believes that the effects of uncorrected misstatements do not cause the
    • financial statements to be materially misstated, the auditor should
    • consider the risk of further misstatement before reaching a final
    • conclusion. According to SAS No. 107 (AU 312.65),
    • even if the auditor concludes that the effects of uncorrected
    • misstatements, individually or in the aggregate, do not cause the
    • financial statements to be materially misstated, the auditor recognizes
    • that there is a risk that the financial statements may be materially
    • misstated due to further misstatement remaining undetected. If combined
    • uncorrected misstatement is very close to the amount an auditor
    • considers material to the financial statements taken as a whole, the
    • risk of further misstatement may be considered unacceptable. For
    • example, if an auditor considers $20,000 material and uncorrected
    • misstatement is $5,000, the risk of further misstatement of $15,000 may
    • be considered acceptably low. If combined uncorrected misstatement is
    • very close to $20,000, the risk may be considered unacceptably high.
  16. Evaluating the Existence of Fraud

    810.16 If the auditor believes
    fraud may have occurred, even if the effect is immaterial to the
    financial statements, the auditor should evaluate its implications for
    the audit.
    • Those implications may be more
    • significant if management is involved. If management is involved,
    • questions about management's integrity may raise doubts about the
    • auditor's ability to rely on representations made during the audit. In
    • that case, the auditor should reevaluate his or her assessment of fraud
    • risks and reconsider the adequacy of audit procedures and the control
    • risk assessment.
  17. 810.17 If the auditor believes
    fraud may have occurred that is material to the financial statements, or
    if he or she is unable to evaluate its materiality, the auditor should:
    a. attempt to determine whether material fraud has occurred and its effects on the financial statements and auditor's report;

    • b.
    • discuss the matter and the approach for any further investigation with
    • an appropriate level of management (at least one level above those
    • involved) and those charged with governance;

    c. suggest that the client consult with legal counsel, if appropriate; and

    d. consider the implications for other aspects of the audit.
  18. 810.18 In some cases, the risk of
    material misstatement of the financial statements due to fraud is so
    significant that auditors should consider withdrawing from the
    engagement
    • and communicating the reasons for
    • their withdrawal to those charged with governance. The decision to
    • withdraw may depend on whether the identified risks call into question
    • the integrity of management and whether management or others with
    • oversight are diligent and cooperative in investigating the situation
    • and taking appropriate action. The authors believe that auditors
    • considering withdrawal should consult with legal counsel.
  19. Documentation Requirements

    810.19
    To evaluate the combined effect of various uncorrected misstatements,
    it is necessary to summarize them in one place in the workpapers. SAS
    No. 107 (AU 312.69) states that the auditor should prepare documentation of the following:
    • A summary of uncorrected misstatements, other than trivial ones, related to known and likely misstatements. Paragraph 810.8 discusses trivial misstatements.

    • The auditor's conclusion as to whether uncorrected misstatements,
    • individually or in the aggregate, do or do not cause the financial
    • statements to be materially misstated, and the basis for that
    • conclusion.

    • • All known and likely misstatements
    • identified by the auditor during the audit, other than trivial ones,
    • that have been corrected by management. The “Closing Entry and Audit
    • Adjustment Form” at HOA-CX-12.1
    • provides for documentation of audit adjustments, whether they relate to
    • known or likely misstatements, discussion with the client, and whether
    • the client has booked the adjustment.
  20. 810.20 Summary of Audit Differences
    An auditor has to combine, or aggregate, the effect on the financial
    statements of all likely misstatements (including known misstatements)
    to evaluate whether the financial statements taken as a whole are
    materially misstated.
    • According to SAS No. 107,
    • misstatements should be combined in a way that enables the auditor to
    • consider whether the misstatements in individual amounts, subtotals, or
    • totals in the financial statements materially misstate the financial
    • statements taken as a whole. That simply means the auditor needs to
    • consider not only the materiality of individual misstatements, but also
    • their combined effect on important financial statement totals or
    • subtotals. A suggested form for accumulating and evaluating
    • misstatements is presented in the “Audit Difference Evaluation Form” at HOA-CX-12.2.
  21. 810.21 Two methodologies have been used in practice to aggregate differences—the rollover method and the iron curtain method.
    • Some firms use the rollover method; others use the iron curtain
    • method. The main difference between the two methods is how the effects
    • of prior-period misstatements are considered. The rollover method
    • considers all misstatements (current-period misstatements as well as the
    • impact of prior-period waived adjustments on current-period income).
    • The iron curtain method focuses on the impact of misstatements on the
    • audited balance sheet and considers the effect on current-period
    • income of amounts needed to correct the balance sheet. The “Audit
    • Difference Evaluation Form” at HOA-CX-12.2
    • is set up to accommodate the rollover method; however, it can easily be
    • modified to use the iron curtain method, if the auditor so chooses, by
    • simply failing to include prior-year waived adjustments that have no
    • effect on current year assets, liabilities, or ending equity. For
    • further information regarding the rollover and iron curtain methods, see
    • the discussion in section 1812 of PPC's Guide to Audits of Nonpublic Companies.
  22. Evaluation of Overall Materiality

    810.22 The combined effect of
    uncorrected misstatements on various financial statement components
    (amounts, subtotals, or totals) should be compared to the amount that
    the auditor considers material to the financial statements taken as a
    whole.
    • The auditor's judgments about materiality in audit planning (see Chapter 6)
    • may be different than materiality used in evaluating audit findings
    • because it is not possible to anticipate everything that could
    • ultimately influence judgments about materiality when evaluating audit
    • findings at completion of the audit. For example, while performing the
    • audit, the auditor may become aware of quantitative or qualitative
    • factors that were not initially considered but could be important to
    • users of the financial statements. Those factors should be considered in
    • making materiality judgments about audit findings. If the auditor
    • concludes that a lower materiality level than initially determined is
    • appropriate, the auditor should reconsider tolerable misstatement and
    • appropriateness of the nature, timing, and extent of further audit
    • procedures. If the nature of identified misstatements and the
    • circumstances of their occurrence indicate that other misstatements may
    • exist that could be material when aggregated with identified
    • misstatements, the auditor should also consider whether the overall
    • audit strategy and audit plan need to be revised.

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