The misstatements and their effects of great importance and auditor consider these effects for their implications on financial statements and auditor’s report. The auditor considers whether uncorrected and undetected misstatements have material and pervasive effect or just material but not pervasive while drafting auditor’s report.
Although auditor considers these two characteristics of misstatements collectively to assess the misstatements in the best possible way but the two effects or characteristics are different and not one and the same.
The effect of misstatement is material when information with such misstatement can effect the decisions of the users of the financial statements. In other words it is the effect of material misstatement on financial information that is used by users of financial information for economic decision making purposes. This effect can be caused by an individual misstatement or by different misstatements taken together i.e. in aggregate. The main thing to remember is that when the effect of misstatement is material then financial information as a whole or part of the financial information which is misstated may cause users to reach wrong conclusions based on such misstated information.
The effect of misstatement is pervasive when such misstatement is not confined to one element, account or item of financial statement and even if it is so confined, it represents a substantial portion of financial statements. In simple words pervasive effects relates to the scope of the effect which reflects the wide spread effect of misstatement.
A term used, in the context of misstatements, to describe the effects on the financial statements of misstatements or the possible effects on the financial statements of misstatements, if any, that are undetected due to an inability to obtain sufficient appropriate audit evidence. Pervasive effects on the financial statements are those that, in the auditor’s judgment:
- Are not confined to specific elements, accounts or items of the financial statements;
- If so confined, represent or could represent a substantial proportion of the financial statements; or
- In relation to disclosures, are fundamental to users’ understanding of the financial statements.
Pervasive misstatement does not automatically means that it is material as well. Same goes for material misstatement which is not always pervasive also. However, usually pervasive misstatement may amount to material misstatement as well.
For example, cash embezzlement by cashier is discovered. This fraud be material in nature but it will hardly be pervasive whereas if the same embezzlement is discovered in relation to key personnel in the management then it is bound to have pervasive effect as many other assertions might also be misstated.
Audit has to consider both characteristics of the misstatements in order to correctly understand the implications of misstatements on the financial statements and auditor’s report. That is why auditor always evaluate whether uncorrected/undetected misstatements are:
- material and pervasive in which case auditor will give adverse or disclaimer of opinion according to the circumstances; or
- just material but not pervasive in which case the auditor will express a qualified opinion.
It is auditor who determines whether misstatements are both material and pervasive or not using his professional judgement.