Materiality

Definition of Materiality:

If there is a substantial likelihood that the fact would have been viewed by a reasonable investor as having significantly altered the total mix of information made available

Four Ways Materiality is Used in the Audit:

1. Planning audit procedures

2. Evaluating errors

3. Considering undetected errors

4. Forming an opinion

Different Levels of Materiality:

• Overall

• Performance/Planning

• Tolerable Misstatement/Error

• Clearly Trivial Amount

What is Performance/Planning Materiality:

• Materiality for classes of transactions, account balances, or disclosures

• Typically 25%-50% lower than overall

What is Tolerable Misstatement/Error:

Amount of misstatements an account balance that the auditor could tolerate and still not judge the balance to be materially misstated

What is the Clearly Trivial Amount:

An amount that is inconsequential to the financial statements

What are Materiality Benchmarks

Can be based on revenue, EBITDA, 5% of income, etc.

How do aggregation and offsetting affect materiality:

You can add things together to make something material but you cannot offset to make something immaterial

What are some of SAB 99’s Qualitative Factors:

• Hiding failure to meet analysts’ consensus expectations

• Changing losses into income, or vice versa

• Concerning an segment playing a significant role in operations or profitability

• Affecting compliance with:

  • Regulatory requirements

  • Loan covenants

  • Increases in management compensation

What is the Rollover Method for Correcting Errors:

It quantifies income statement errors based on an amount that the income statement is misstated - including the reversing effect or any PY misstatement

What is the Iron Curtain Method for Correcting Errors:

It quantifies income statement errors based on the amount that income statement would be misstated if the accumulated balance sheet errors were corrected in that period

Which methods do you use to determine if the misstatement is material in the current year:

Both

Which methods do you use to determine if the previously issued financial statements were materially misstated:

Only the rollover

Three Methods of Error Correction:

Reissuance Restatements, Revision Restatements, and Out-of-Period Adjustments

What are Reissuance Restatements:

Reissuance restatements correct errors in financial statements by issuing new ones that replace the old. They're needed when material errors significantly affect the financial statements. They are announced in a form 8-4 item 4.02.

What are Revision Restatements:

Immaterial errors and misstatements that are corrected by revising the previous periods in the current financial report. They are disclosed in the footnotes of the current financial statements.

What are Out-of-Period Adjustments:

Out-of-period adjustments are made to financial statements to correct errors or recognize events that occurred after the period end date but before the financial statements were issued. These adjustments are disclosed in the footnotes.