Evaluating misstatements under AU-C 450
AU-C 450 has the auditor accumulate misstatements identified during the audit, other than those that are clearly trivial, communicate them to management and request correction. For those that remain uncorrected, the auditor determines whether they are material, individually or in aggregate, considering their size and nature and the effect of uncorrected misstatements from prior periods.
This evaluator records each misstatement twice. Iron curtain is the amount left in the closing balance sheet. Rollover is the effect on this year's income: closing misstatement minus the opening misstatement carried from last year. A prior-year cutoff error that reversed this year has no iron-curtain effect but hits current-year income; a judgmental reserve shortfall that has grown for years may look small on rollover and large on iron curtain. Concluding on the larger of the two avoids both blind spots.
If the aggregate approaches materiality, AU-C 450 has the auditor consider whether the overall audit strategy and plan need revising. This tool flags that when the aggregate passes performance materiality, set with the materiality calculator (AU-C 320).
Common questions
What is a summary of uncorrected misstatements?
It is the schedule of misstatements identified during the audit, other than clearly trivial ones, that management has not corrected. AU-C 450 requires the auditor to accumulate them, evaluate whether they are material individually or in aggregate, and include a summary in, or attached to, the management representation letter.
What is the difference between factual, judgmental and projected misstatements?
Factual misstatements are beyond doubt, such as a recording error. Judgmental misstatements are differences between management’s estimate and the auditor’s view of a reasonable estimate. Projected misstatements are the auditor’s best estimate of misstatement in a population, extrapolated from a sample.
What are the iron curtain and rollover methods?
The rollover method measures a misstatement by its effect on the current-year income statement, including the reversal of prior-year misstatements. The iron curtain method measures the misstatement remaining in the year-end balance sheet. SEC SAB 108 requires public companies to consider both (the dual approach); many auditors of private companies apply it too.
When are uncorrected misstatements material?
When, individually or in aggregate, they could reasonably be expected to influence users’ economic decisions. Compare them with overall materiality and any lower materiality for particular items, and weigh qualitative factors such as covenant breaches, a change from loss to profit, or fraud.
Do prior-year uncorrected misstatements matter?
Yes. AU-C 450 requires the auditor to consider the effect of uncorrected misstatements related to prior periods on the relevant classes of transactions, account balances or disclosures, and on the financial statements as a whole.
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