What is a judgmental misstatement?
ISA 450.A1 defines judgmental misstatements as differences arising from the judgments of management concerning accounting estimates that the auditor considers unreasonable, or the selection or application of accounting policies that the auditor considers inappropriate. The key word is unreasonable. Management is permitted to exercise judgment. The auditor's role is to determine whether that judgment falls within an acceptable range.
ISA 540.18 requires the auditor to first determine whether management's estimate falls within a reasonable range. Only when it falls outside that range does it become a misstatement. This is where most files break down: the team identifies a difference between management's figure and the auditor's point estimate and records the entire difference as a misstatement, rather than measuring from the boundary of the acceptable range.
Documenting a judgmental misstatement demands more than recording the arithmetic. The auditor must explain why management's position is unreasonable, not merely that it differs from the auditor's preference. This requires setting out the acceptable range, the evidence supporting that range, and the reason management's figure falls outside it.
Key Points
- Requires the auditor to demonstrate why management's position is unreasonable, not merely different.
- Accumulating judgmental misstatements demands more documentation than factual errors.
- Inspection findings frequently cite insufficient reasoning when a judgmental misstatement is identified but not corrected.
- Management can legitimately hold a different view; the auditor determines whether that view falls outside the acceptable range.
Why it matters in practice
The FRC's 2023 annual inspection report flagged cases where auditors identified a difference between management's estimate and the auditor's own figure but did not document why management's position was unreasonable. Identifying a difference is not enough. The file must show the reasoning.
A common error is accumulating the misstatement at the auditor's point estimate rather than at the boundary of the acceptable range. If the auditor's range is €15M–€18M and management records €22M, the misstatement is €4M (the distance from the nearest boundary), not €6M (the distance from the auditor's mid-point).
Worked example: Leclercq Holding S.A.
Client: Belgian holding company, FY2024, revenue €135M, IFRS reporter.
Leclercq holds a 40% stake in Vosmont Logistics with a carrying amount of €22M. Vosmont has reported operating losses in FY2023 and FY2024, and its primary contract (55% of revenue) expires June 2025 with no renewal confirmed.
Auditor's cross-check (value in use): The auditor assigns a 50% renewal probability (vs management's 85%) and a discount rate of 11.5% (vs management's 9.2%), based on observable market data and the absence of written confirmation. Recoverable amount: €16.8M vs carrying amount €22M. The difference of €5.2M exceeds performance materiality of €2.7M.
Management's response: Management declines to impair, citing verbal assurances from the counterparty. No written confirmation is available.
Audit conclusion: The auditor determines that management's judgment falls outside the acceptable range. The auditor's range for the carrying amount is €15M–€18M. The misstatement is measured from €18M (the nearest boundary), giving a judgmental misstatement of €4M. This is accumulated on the summary of uncorrected misstatements and communicated to those charged with governance.
What reviewers get wrong
The FRC's 2023 report flagged cases where auditors identified a difference but did not document why management's position was unreasonable. Identifying the number is not sufficient. The file must show the auditor's reasoning for concluding the position is outside the acceptable range.
Teams also frequently accumulate at the auditor's point estimate rather than the boundary of the acceptable range. If the range is €15M–€18M and management records €22M, the misstatement is €4M, not €6M. Overstating the misstatement does not make the file more conservative. It makes it wrong.
Key standard references
- ISA 450.A1: Defines judgmental misstatements as differences from judgments the auditor considers unreasonable.
- ISA 540.18: Requires determining whether management's estimate falls within a reasonable range.
- ISA 450.11: Requires the engagement partner to evaluate uncorrected misstatements before forming the opinion.
Related terms
Related reading
Frequently asked questions
Is every difference between management's estimate and the auditor's estimate a judgmental misstatement?
No. ISA 540.18 requires the auditor to first determine whether management's estimate falls within a reasonable range. Only when it falls outside that range does it become a misstatement.
How should the auditor measure a judgmental misstatement?
Measure from the nearest boundary of the acceptable range, not from the auditor's point estimate. If the auditor's range is €15M–18M and management records €22M, the misstatement is €4M.