Under generally accepted auditing standards (GAAS), a misstatement is a difference between the reported amount, classification, presentation or disclosure of a financial statement item and what the applicable financial reporting framework requires for that item to be presented fairly, and misstatements can arise from fraud or error (AICPA, AU-C 450, Evaluation of Misstatements Identified During the Audit, .04). The same definition carries a second branch, that misstatements also include the adjustments of amounts, classifications, presentations or disclosures that, in the auditor’s professional judgment, are necessary for the financial statements to be presented fairly, in all material respects.
Material Misstatement Is a Separate Judgment
Nothing in that definition mentions size. A difference is a misstatement whatever its magnitude, and whether it matters is the separate materiality judgment made afterwards. GAAS writes that sequence into the standard, having the auditor accumulate identified misstatements during fieldwork and determine only later whether the uncorrected ones are material, individually or in the aggregate (AICPA, AU-C 450, .05 and .11).
The rulebook for public company audits words the definition from the effect end rather than the difference end. There a misstatement, if material individually or in combination with other misstatements, causes the financial statements not to be presented fairly in conformity with the applicable financial reporting framework (PCAOB, AS 2810, Evaluating Audit Results, .A2). The same paragraph then gives the difference-based description GAAS uses, and adds that misstatements can arise from error, meaning unintentional misstatement, or from fraud.
The split survives the change of wording. There too the auditor accumulates first and weighs materiality only afterwards, against the items left uncorrected (PCAOB, AS 2810, .10 and .17). Neither rulebook treats an immaterial difference as something other than a misstatement.
The Three Types of Misstatement Under GAAS
To evaluate the effect of misstatements accumulated during an audit, and to communicate them, the auditor may find it useful to distinguish factual, judgmental and projected misstatements (AICPA, AU-C 450, .A6). Factual misstatements are the ones about which there is no doubt. Judgmental misstatements are differences arising from management’s own judgments about recognition, measurement, presentation and disclosure, including the selection or application of accounting policies, that the auditor considers unreasonable or inappropriate. Projected misstatements are the auditor’s best estimate of the misstatement in a population, reached by projecting the misstatements found in a sample onto the population it was drawn from, the mechanics of which sit in statistical sampling.
The standard offers that split as useful rather than required, so a firm that sorts its passed adjustments some other way has broken no rule. Projection itself is required on both sides, and only its location differs. GAAS puts the duty in the sampling section, where the auditor should project the results of audit sampling to the population (AICPA, AU-C 530, Audit Sampling, .13). The public company standard writes it into the accumulation requirement itself, so that the auditor’s accumulation should include the auditor’s best estimate of the total misstatement in the accounts and disclosures tested, not just the amount of misstatements specifically identified (PCAOB, AS 2810, .12).
Fraud or Error Names the Cause, Not the Direction
Cause and direction are different axes. Overstated and understated say which way the reported figure is wrong. Fraud and error say why. Misstatements can arise from either, and the distinguishing factor between the two is whether the underlying action that results in the misstatement is intentional or unintentional (AICPA, AU-C 240, Consideration of Fraud in a Financial Statement Audit, .02). How the intentional half divides, and the conditions that organize fraud risk, are set out in the fraud triangle.
A third axis is what the misstatement is wrong about, which is the assertions it lands against. Transactions never recorded at all fail completeness.
Accumulating Misstatements, and the Ones Management Leaves Alone
The auditor accumulates misstatements identified during the audit other than those that are clearly trivial, a floor the standard is careful to keep separate from immateriality, because clearly trivial items are of a wholly different and smaller order of magnitude, or of a wholly different nature, than those that would be determined to be material (AICPA, AU-C 450, .05 and .A2). An uncorrected misstatement is one the auditor accumulated during the audit that has not been corrected (.04). The public company definition is worded from the other end, as misstatements other than those that are clearly trivial that management has not corrected (PCAOB, AS 2810, .A3).
What the auditor documents about that list, and what management is asked to represent about the items it declines to correct, is worked through in year-end audit preparation.
When a Misstatement Reaches Statements Already Issued
A misstatement found during fieldwork gets corrected or passed. One found in statements that have already gone out is a different problem, governed by FASB Accounting Standards Codification Topic 250, Accounting Changes and Error Corrections. That is the standard an SEC registrant points at when its board of directors, a committee of the board, or the officer or officers authorized to act if board action is not required, concludes that previously issued financial statements should no longer be relied upon because of an error in them (SEC, Form 8-K, Item 4.02(a)), the disclosure route covered under Form 8-K.
The auditor’s report moves as well. Where previously issued financial statements are restated to correct a material misstatement, the auditor includes an emphasis-of-matter paragraph stating that they have been restated for that correction in the respective period and referring to the entity’s disclosure of it (AICPA, AU-C 708, Consistency of Financial Statements, .13 and .14).
Common Questions
In ordinary English it means an incorrect statement of fact, with no framework and no auditor standing behind the comparison. In the accounting sense only an amount, a classification, a presentation or a disclosure is misstated, and always against what the applicable financial reporting framework requires.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms on accounting and tax work rather than audit fieldwork, and a firm can grade a block of its own work through a trial task.
