Accounting is a complex and challenging task, so it’s no surprise that many business owners make mistakes while bookkeeping. But financial management is a crucial part of any business, so even small mistakes can have big consequences. If your business gets an audit and the auditor finds a mistake, you would call that mistake a misstatement.

This article will look at what a misstatement in accounting is and how you can prevent them. We’ll cover a variety of topics, including:

  • What is a misstatement in accounting?
  • What are the types of misstatements?
  • What are the consequences of misstatements?
  • How can I avoid misstatements? 

What is a misstatement in accounting?

An audit is an official investigation into your business finances by the government, usually to find out if you’re paying the right amount of tax. An auditor is a financial professional who conducts the audit.

The official definition of a misstatement is a difference between actual financial statement items prepared by the subject of an audit and those required by applicable accounting standards. 

In simpler terms, it means that an auditor finds something on a financial document to be incorrect. This ‘something’ could be the value of a particular asset, the amount you spent over a specific period, or your sales revenue for the year.

For example, say the auditor is looking over your profit and loss statement for the previous month and finds an extra zero at the end of your net profit. This mistake is a misstatement. An auditor ‘accumulates’ misstatements; this just means they are finding and listing more errors. 

Once they find a misstatement, the auditor will go through all of your records to ensure they have the correct information. They’ll then do the calculations necessary to get the correct figure. 

Types of misstatement

There are three different types of misstatement:

Factual

A factual misstatement is when there is no doubt that an item on a financial document is incorrect. An auditor will know that a misstatement is factual because they’ll check your records to find the correct item instead. 

The example we gave above about a wrong net profit figure is a factual misstatement. Another example would be listing an inventory purchase as a profit instead of a loss. Since you spent the cash on inventory, you lost money, so listing it as a profit is incorrect.

Judgemental

When your auditor disagrees with a projection or predictions on your documents, this is a judgemental misstatement. These are commonly the result of inexperienced business owners. 

For instance, say a business owner is preparing a cash flow forecast. They don’t have the experience or accounting knowledge to make a more accurate prediction, but they write down their best guess. During a future audit, the auditor finds the inaccurate guess and lists it as a judgemental misstatement.

Projected

This is a slightly different kind of misstatement and might not be relevant to your audit, but it can affect the audits of others. A projected misstatement is when an auditor estimates misstatements that are likely to be found in a certain population. They base this on misstatements they’ve found during other audits within that population.

The government will use projected misstatements to decide if other businesses in the area may require audits.

What are the consequences of misstatements?

Material misstatements

Material misstatements are when a misstatement has an impact beyond being a mistake on a financial statement. These are what auditors are generally looking for during audits, as they can affect other businesses. 

Let’s look at an example of a material misstatement. Say you have a misstatement in the accounts of your limited company that imply your stock will increase in value, which encourages an investor to buy your stock. When that misstatement is found and corrected, the stock value will drop, and the investor will lose money. 

This will affect your relationship with your investors and (if the misstatement is intentional) can have severe legal consequences.

Consequences of intentional misstatements

A company might intentionally write incorrect information in their financial statements so that they can pay less tax. This is known as tax evasion, and can lead to serious punishments. For example, a business owner found guilty of tax evasion can receive a sentence of up to seven years in prison and an unlimited fine. 

How can I avoid misstatements?

Using an accountant 

Using an accountant when creating important financial documents is probably the best way of avoiding misstatements. If you’re unsure when filing your tax documents, hiring an accountant to check everything and make sure it’s entirely correct is smart.

Chartered accountants are highly experienced and accredited accountants that generally specialise in a particular area of accounting. If you know you already have misstatements in your accounting, or you have an audit coming up, you might want to speak with a chartered accountant so they can correct any mistakes.

Using a business account 

Financial management can be stressful and time-consuming when you’re self-employed. The threat of legal consequences and audits only makes the task more stressful. This is just one of the reasons why thousands of business owners use the Countingup app to make their financial admin easier. 

In particular, Countingup’s automatic expense categorisation helps massively with creating accurate financial statements. As soon as you make a transaction on your Countingup business account, it goes into an HMRC-approved category in your records. 

Countingup is the unique business current account with built-in accounting software that allows you to manage all your financial data in one place. With features like invoicing on the go, receipt capture tools, tax estimates, and cash flow insights, you can confidently keep on top of your business finances wherever you are. 

You can also share your live bookkeeping data with your accountant instantly without worrying about duplication errors, data lags or inaccuracies.

Find out more here.

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