Lessons · Accounting · where a misstatement is likely to be
Where a misstatement is likely to be
Audit effort is directed at risk rather than spread evenly. Risk is higher where amounts depend on judgement, where somebody benefits from a particular answer, where the process is manual, and where the balance is large relative to everything else.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
In beta. This lesson was written for Hone and has not yet been checked by a qualified accountant. Practice material, not professional advice. What that means.
What it is for
There is never enough time to test everything equally, so the plan is a decision about where to spend it. An audit that gives the same attention to a bank balance that can be confirmed in a day and to a provision management estimated has misallocated its whole budget.
How to think about it
Rank balances by how much judgement they involve and who benefits from the judgement going one way. Start at the top of that list, not at the top of the balance sheet.
Worked example
Cash at bankConfirmable directly, little judgement. Lower risk.
A warranty provisionAn estimate of the future by people whose results it affects.
Revenue near the year endTiming decides which year it falls in, and somebody has a target.
A related party transactionBoth sides of it may have the same interest.
Your turn
Name what makes a balance higher risk, besides its size.
Risk rises where the amount depends on
Solve one, graded on the server
The trap
Planning by size alone. The largest balance is often the easiest to verify, and the misstatement that matters is usually hiding in a smaller number that somebody had to decide.