Work through likelihood, magnitude, compensating controls and indicators to see an indicative classification: control deficiency, significant deficiency or material weakness. A guide for structuring the judgement, not a conclusion.
This is an indicative guide. The classification is a judgement made against the current standard and your methodology, and needs documented rationale and review.
A control deficiency exists when a control does not let people prevent or detect misstatements on time. A significant deficiency is less severe than a material weakness but important enough to merit the attention of those overseeing financial reporting. A material weakness is a deficiency, or combination, with a reasonable possibility that a material misstatement would not be prevented or detected on a timely basis. “Reasonable possibility” means more than remote.
Severity depends on two things: whether there is a reasonable possibility that the control failure would let a misstatement through, and how large that misstatement could be. If there is a reasonable possibility and the misstatement could be material, the deficiency points to a material weakness. If it could be important but less than material, it points to a significant deficiency.
Compensating controls can lower severity only if they operate at a sufficient level of precision and have been tested. Several deficiencies affecting the same account can add up to something more severe than each alone. Certain indicators, such as fraud by senior management, restatement of earlier statements, a material misstatement found by the auditor that controls would not have caught, and ineffective audit committee oversight, point strongly toward a material weakness.
This tool follows that logic in steps and shows its working. The result is an aid to your own documented judgement.
Management reviews manual journal entries only occasionally. A reasonable possibility exists that an erroneous entry could pass through, and the amounts involved could be material. No other control covers it.
