Misstatement in the Financial statements
Errors vs. Fraud
Misstatements in the financial statements occur because of error
and fraud. Errors are unintentional misstatements or omissions in
financial statements. Fraud, in contrast, in an intentional
misrepresentation of a material fact that includes fraudulent
financial reporting and misappropriations of assets.
Errors – refer to mistakes or unintentional misstatements or
omissions of amounts or disclosures in the financial statements.
Examples:
Mistakes in gathering or processing data from which FS are
prepared
Incorrect accounting estimate arising from oversight or
misinterpretation of facts
Mistake in applying accounting principles
Fraud – intentional misstatements or omissions of amounts or
disclosures in the financial statements
The term “fraud” refers to an intentional act by one or more
individuals among management, those charged with governance,
employees or third parties, involving the use of deception to obtain
an unjust or illegal advantage.
The factor that distinguishes fraud from error is whether the
underlying action is intentional or unintentional.
Evaluation of Misstatements Identified
Fraud is harder to detect than errors: Reasons:
a) Fraud may involve sophisticated and carefully organized
schemes designed to conceal it.
b) Fraud may be accompanied by collusion
It is difficult for the auditor to detect fraud. But the auditor is
required to assess the risks of material misstatements arising from
fraud exists.
Some errors can occur during the period but discovered within the
reporting period. There is no problem with this because the error
can simply be corrected by reversing the erroneous transaction.
Other errors are not discovered immediately and were reflected on
the financial statements issued in prior periods. When errors of this
kind are discovered, careful analysis is necessary to determine the
required action to rectify account balances. Such errors are called
prior period errors.
Prior period errors
Prior period errors are omissions and misstatements in the entity’s
financial statements for one or more periods arising from a failure
to use or misuse of reliable information that:
a) Was available when financial statements for these periods
were authorized for issue.
b) Could reasonably be expected to have been obtained and
taken into account in the preparation and presentation of
those financial statements.
Treatment of prior period errors
An entity shall correct material prior period errors retrospectively in
the first set of financial statements authorized for issue after their
discovery by:
a) Restating the comparative amounts for the prior period
presented in which the errors occurred.
b) Restating the opening balances of assets, liabilities and
equity for the earliest prior period presented if the error
occurred before the earliest period presented.
In other words, a prior period should be corrected as if the errors
have never occurred.
Moreover, in a prior period error, the correction of an error does not
affect profit or loss for the period in which the error is discovered
but it is an adjustment of the beginning balance of retained
earnings of the earliest period presented.
TYPES OF ERRORS
a) Statement of financial position errors
b) Income statement errors
c) Combined statement of financial position and income
statement errors
Statement of Financial Position or Balance sheet errors
Statement of financial position or balance sheet errors affect only
the presentation of an asset, liability, or stockholders’ equity
account.
When the error is discovered in the error year, the company
reclassifies the item to its proper position.
If the error in a prior year is discovered in a subsequent period, the
company should restate the statement of financial position of the
prior year for comparative purposes.
