ISA 320 (Revised) Materiality in Planning - Performing an Audit/ISA 450 Evaluation of Misstatements Identified during the Audit
Proposed redrafted International Standards on Auditing issued for comment by the International Auditing and Assurance Standards Board of the International Federation of Accountants
Comments from ACCA
February 2007
Executive Summary
ACCA welcomes the opportunity to comment on the proposed redrafted International Standards on Auditing ISA 320 (Revised) Materiality in Planning and Performing an Audit (proposed ISA 320) and ISA 450 Evaluation of Misstatements Identified during the Audit (proposed ISA 450), issued for comment by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC).
ACCA commented in April 2005 on an exposure draft of ISA 320, which has subsequently resulted in finalised 'close-off' documents. Our comments below are restricted to the changes proposed in applying the drafting conventions of the Clarity project to those documents.
We are, nevertheless, disappointed that the IAASB has not invited comments on the creation of a wholly new ISA during the 'close-off' of comments on proposed ISA 320. The 'Basis for Conclusions' document issued with the proposed ISAs justifies addressing materiality and misstatements in separate ISAs on the basis that, 'respondents were confused by the flow of the document' . We do not feel that this is a sufficient justification to create a wholly new ISA.
This action has produced consequences that could not be anticipated by respondents to the exposure draft of ISA 320. Accordingly we do not believe that the IAASB is following due process in stating that it will not accept comments dealing with such matters.
In relation to proposed ISA 450, we are particularly concerned that the considerations as the audit progresses (paragraphs 12 and 13) and the associated documentation requirements may be interpreted in this stand-alone ISA as requiring auditors to document a quantified materiality level for the audited financial statements.
This is clearly inappropriate as auditor judgement only extends in that regard to whether any uncorrected misstatements are material, a consideration that takes into account many factors. This matter should be addressed in application guidance.
In relation to the application of the Clarity drafting conventions, we have concerns that:
- Certain objectives and requirements are out of step with each other.
- There is insufficient justification for many of the proposed requirements.
Objectives
Proposed ISA 320
The objective in proposed ISA 320 suggests that the auditor always reconsiders materiality as the audit progresses, whereas the requirement in paragraph 12 only requires revision in the event of becoming aware of information that would prompt reconsideration. The two are different, with the objective being more onerous - requiring apparently ongoing reconsideration even if not triggered by identified matters. The objective should be revised to align with the requirement.
Proposed ISA 450
The objective is appropriate.
Application of the Clarity Drafting Conventions
Proposed ISA 320
The section on materiality in the context of an audit (which has been created as part of the clarity drafting) presents, in paragraph 4, a list of user characteristics against which auditors are to judge materiality. The change in wording from that in the exposure draft is explained in the 'Basis for Conclusions' document, which reports that many respondents expressed concern about guidance relating to the characteristics of users. It goes on to say that 'the purpose of the guidance was not, as suggested by some respondents, to define users but rather to define the context in which users of the financial statements make decisions.'
In the context of ISAs, the word 'reasonable' is associated with a 'high but not absolute' level of assurance. The words 'reasonable knowledge' and 'reasonable diligence' used in the text, place the users, therefore, at a very high level of skill and application. This is clearly not the case, in practice, for the vast majority of audited entities. It is not appropriate for proposed ISA 320 to indicate, therefore, that 'it is reasonable for the auditor to assume that users [have such characteristics]' . Instead, proposed ISA 320 should indicate that it is written on this assumption.
Proposed ISA 450
Many of our comments below on the application of the Clarity drafting conventions are in relation to new requirements that increase the degree of specificity of proposed ISA 450.
Many of the proposed requirements are overly detailed and will deter the use of auditor judgement in the important area of evaluation and communication of misstatements. We recommend that the proposed requirements be reconsidered on an individual basis and that each remains as a requirement only if a strong case can be made for that.
Paragraph 5
Paragraph 5 contains a requirement to accumulate misstatements; distinguishing between factual misstatements, judgmental misstatements and projected misstatements. The wording about the types of misstatements originates from paragraph 7 of the close-off document. In that paragraph it is clearly only advisory (being introduced by the words 'it is useful to distinguish between . . .' ).
Other than in relation to documentation, proposed ISA 450 makes no distinction between the types of misstatements in any of its other requirements. The requirement to distinguish between the types of misstatements should, therefore, be removed.
Paragraph 8
Paragraph 8 is turning into a requirement something that is conditional on management having done something in particular circumstances that will not be present in virtually all audits. The actions will, in any case, be considered by auditors, as otherwise they may not be able to obtain sufficient appropriate evidence. As such, there is no need for a specific requirement.
If retained, the requirement is too narrow and may deter auditors from taking appropriate action in other circumstances, for example where management fails to correct misstatements that were found.
Paragraph 10
The proposed requirement in paragraph 10 has two parts: to obtain an understanding and to take that into account in one particular circumstance. Auditors who obtain an understanding should not have that artificially constrained by a requirement that deters its wider use. Obtaining such an understanding is integral to negotiating with management over the correction of misstatements and its use can be left to auditor judgement.
If the requirement in paragraph 9, to request that management correct all misstatements, is retained, the most common reason that management will cite for not doing so is cost-effectiveness. This reason is of minor relevance to any consideration by the auditor as to whether the financial statements as a whole are free from material misstatement.
Paragraph 14
The word 'also' is unnecessary.
Paragraph 15
The requirement to address items individually is relaxed by paragraph A20, which permits aggregation. This is not an appropriate way for the application material to be used. The need for this wording arises because the proposed requirement is itself wrong. It does not satisfy the criteria for inclusion as a requirement as it will not be appropriate in the vast majority of cases: inevitably, many more small errors are detected than large.
Paragraph 16
Paragraph 16 is a mix of explanatory material and repetition of aspects of paragraph 15. Such communication should not be constrained by detailed requirements, which introduce inefficiencies and deter effective communication.
It is a matter of auditor's judgement as to how best to communicate such matters. The application material may provide guidance.
Paragraph 17
For the reasons set out in relation to paragraph 16, auditors should not be required to communicate the effect of uncorrected misstatements related to prior periods separately from other uncorrected misstatements. It is a matter of auditor's judgement as to how best to communicate such matters in the overall context of uncorrected misstatements.
Paragraph 17 follows on from the decision to require separate treatment of uncorrected misstatements related to prior periods (paragraph 14). However, to the extent that the IAASB feels that there is a need to make such concepts 'flow through the document' , this can be done in the Application and Other Explanatory Material.
Paragraph 20
The documentation requirement at paragraph 20 (b) should be rewritten to remove reference to distinguishing between factual misstatements, judgmental misstatements and projected misstatements. This is a change consistent with correcting the error referred to in relation to paragraph 5 above. The proposed requirements between paragraphs 5 and 20 make no mention of the three categories.