A4 M7 Misstatements Discovered During an Audit

Evaluation of Audit Results

Requires evaluating analytical procedures, misstatements, qualitative accounting practices, fraud risk conditions, financial statement presentation, and evidence sufficiency.

Accumulation of Misstatements

Mandates accumulating all identified misstatements except those that are clearly trivial (inconsequential by any size, nature, or circumstance).

Clearly Trivial Threshold

An amount set by the auditor below which misstatements do not need to be accumulated, ensuring undetected misstatements will not cause a material impact.

Evaluation of Misstatements Materiality

Requires evaluating uncorrected misstatements individually and in the aggregate against financial bases (e.g., net income, total assets) and considering qualitative factors.

Qualitative Factors Increasing Materiality

Includes masking trend changes, affecting covenant compliance, increasing compensation, involving fraud/bias, or impacting key recurring elements/segments.

Evaluating Management Bias

Involves assessing potential bias in accounting estimates, selective correction of misstatements, or booking offsetting adjusting entries.

Communication with Management

Requires timely communication of accumulated misstatements to management, requesting their correction and re-testing remaining amounts.

Uncorrected Misstatements Procedure

Requires obtaining management's reasons for refusal, evaluating overall statement misstatement, and warning management of future period impacts.

Audit Documentation Requirements

Demands documenting the trivial threshold, accumulated/corrected misstatements, materiality conclusions, aggregate effects, and covenant/ratio impacts.

Effect on Control Risk Assessment

Identified material misstatements indicate material weaknesses in internal control, requiring reassessment of control risk, sample sizes, and the audit risk model.

Natural Account Balances for Adjustments

Assets and expenses have natural debit balances; liabilities, stockholders' equity, and sales/revenues have natural credit balances.

FOB Shipping Point (Purchases/Sales)

Inventory belongs to the buyer as soon as it is delivered to the carrier; buyer includes it, and seller excludes it.

FOB Destination (Purchases/Sales)

Inventory belongs to the buyer only when it reaches the buyer's place of business; buyer includes it upon arrival, and seller excludes it upon arrival.

Perpetual Inventory Accounting

Records revenue alongside debiting cost of goods sold and crediting inventory simultaneously at the time of sale.

Periodic Inventory Accounting

Records revenue at sale time and calculates cost of goods sold at period end based on beginning inventory plus purchases minus physical ending inventory count.

Consignment Rules

Audit client excludes inventory held as a consignee (goods belonging to others) and includes inventory in the hands of consignees as a consignor.

Forming Conclusions

Evaluating audit results requires analyzing analytical procedures from overall reviews, accumulated misstatements, qualitative accounting practices, fraud conditions, financial statement presentation/disclosures, and overall evidence sufficiency.

Identification of Misstatements

Accumulates all identified misstatements during the audit except those that are clearly trivial (inconsequential by any size, nature, or circumstance).

Evaluation of Misstatements

Evaluates uncorrected misstatements individually and in the aggregate against relevant financial bases (e.g., net income, total assets) while considering qualitative factors like trend changes, loan covenants, or management bias.

Communication Requirements (Misstatements)

Requires timely communication of all accumulated misstatements to the appropriate level of management with a request for correction, including informing management of future period impacts if uncorrected.

Documentation Requirements (Misstatements)

Demands documenting the clearly trivial threshold, accumulated and corrected misstatements, overall materiality conclusions, aggregate financial statement effects, and impacts on key ratios or covenants.

Effect of Identified Misstatements on Assessment of Control Risk

Uncovered material misstatements indicate material weaknesses in internal control, requiring the auditor to evaluate the frequency and cause of errors and reassess control risk, sample sizes, and the audit risk model.

Adjusting Journal Entries (General)

Proposed by the auditor to correct client financial misstatements, though management holds final responsibility for deciding whether to book the adjustments.

Overstated or Understated Accounts

To correct misstatements, adjust accounts based on their natural balances: debit assets/expenses to increase and credit to decrease; credit liabilities/equity/revenue to increase and debit to decrease.

Purchases Adjustments

Determined by physical ownership of goods at year-end, which depends on whether the client is the buyer or seller and the associated shipping terms.

FOB Shipping Point (Client is Buyer)

Goods belong to the client as soon as they are placed with the carrier, so they must be included in the client's inventory and purchase balances.

FOB Destination (Client is Buyer)

Goods belong to the client only after reaching the client's location, so they are excluded from inventory until delivered.

FOB Shipping Point (Client is Seller)

Goods belong to the buyer once delivered to the carrier, so the client must exclude them from inventory and record the sale.

FOB Destination (Client is Seller)

Goods remain the property of the client while in transit, so they must be included in the client's inventory until delivered to the buyer.

Audit Client is Consignee

The client holds goods belonging to another party, so this inventory must be completely excluded from the client's financial statements.

Audit Client is Consignor

The client's goods are held at a third party's location, so this inventory must be included in the client's ending inventory balance.