How can a misstatement in one financial statement, whether intentional or not, a

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How can a misstatement in one financial statement, whether intentional or not, affect a presentation in another financial statement? Give an example of an error that occurs on one financial statement and the error flows through to a second financial statement?

ISA 450 defines a misstatement as a difference between the amounts, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or fraud.

Misstatements arise from inaccurate gathering and processing of information as well as weaknesses in the internal control functions. Incorrect interpretation of facts or oversights can also result in misstatements arising in the financial statements. It is widely recognised that financial statements often contain estimates and judgements, such as accrued expenses, bad debt provisions, inventory provisions and other accounting estimates which may be an incorrect estimate giving rise to misstatements within the financial statements. Fraud can also result in misstatement within the financial statements, and auditors need to consider the provisions in ISA 240.

ISA 450 refers to three types of misstatements:

Factual Misstatements: Factual misstatements are simply misstatements about which there is no doubt. For example, if a bank balance is incorrectly stated within the financial statements.

Judgemental Misstatements: Judgemental misstatements are misstatements by management regarding accounting estimates, or the selection of accounting policies, which the auditor considers unreasonable or inappropriate.

Projected Misstatements: Projected misstatements are the auditor's ‘best estimate’ of misstatements in populations, which involves the auditor projecting errors in audit samples to the entire population from which the sample was drawn.

Anomalous Error : Some misstatements can be isolated, which are referred to as an ‘anomalous’ error. An example of an anomalous error is where an incorrect formula has been included in a spreadsheet cell which calculates the cost of inventory but which has not occurred anywhere else. Conversely, some misstatements might not be isolated and can arise through inappropriate accounting policies, or a failing in internal controls, the effect of which is widespread throughout the financial statements.

Prior Period Uncorrected Misstatements: There is possibility that uncorrected misstatements discovered in the previous audit, which were judged to be immaterial, may well become material misstatements in the current period when aggregated with other misstatements.

Example: There is a material overstatement of revenue in first year so the financial statements as a whole of first as well as second year will be materially misstated because overstatement in revenue is not appropriate and will result in incorrect reporting of profits, current and differed taxes and retained earnings in first as well as second year's financial statements.

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