Materiality in Audit

Materiality

The magnitude of a misstatement that would likely change the judgement of a reasonable f/s user (not absolute, requires professional judgment)

Step 1

Determine a materiality level of the overall financial statements ( preliminary judgment of materiality)

Step 2

Determine tolerable misstatement

Step 3

Evaluate audit findings

Why is materiality important?

1. Planning

2. Evidence evaluation/sampling

3. Reporting

Preliminary Judgment of Materiality (PJM)

Materiality for the f/s as a whole

Quantitative Benchmarks

Income (loss) before income taxes - 3-10%

Total assets - .25-2%

Total revenues - .5-5%

Net assets - 3-5%

Total equity - 1-5%

TM (performance materiality)

• Usually 5-15% of balance or 50-75% of PJM

• Allocation of materiality at the individual account level

Known Misstatements

Misstatements are certain

Likely misstatements

Difference in judgement or extrapolation of audit evidence

• ex: allowance for doubtful account: auditors range ($250k-$285k); client’s estimate = $225k; misstatement = $25k under-statment