Audit Materiality

Audit Materiality

materiality

-definition requires professional judgement

materiality steps

1. overall materiality/planning materiality

2. performance materiality/tolerable misstatement

3. evaluate audit findings

planning materiality/overall materiality

-established for financial statements as a whole

-big overall accounts (assets/liabilities)

-directs attention to accounts that are important/uncertain/susceptible to errors or fraud

performance materiality/tolerable misstatement

-specific/smaller accounts

-basis for designing audit tests-allocate tolerable misstatement to individual accounts or classes of transactions

-make sure that aggregate uncorrected/undetected immaterial misstatements do not exceed overall materiality

evaluate audit findings

-near end of audit

planning stage

-start with overall materiality-5% NIBT

-find tolerable misstatement-75% OM

-find postings threshold-greater than or equal to 5% OM

-find clearly trivial-less than 5% OM

completion stage

-sum of postings threshold per account and ensure less than tolerable misstatement-acct/transaction level

-sum of sum of postings threshold-compare to overall materiality-FS overall

step 1: determine overall materiality

-determine important user

-quantitative factors are percentage of gross benchmarks/total assets/total equity/total revenues-0.5%-3%

-net benchmarks (3-5%)-income from continuing operations/3 year average income before taxes/net assets/gross profit

-quantitative amounts may be adjusted lower for qualitative factors of first year engagement/material misstatement in prior years/high fraud risk/potential loan covenant violations/high market pressure/volatile business environment/higher than normal risk of bankruptcy

step 2: determine tolerable misstatement

-amount of planning materiality allocated to an account or class of transactions

-combined is greater than planning materiality

-not all account misstated by the full allocation of this

-audits of individual accounts are conducted simultaneously-can adjust amount/focus on issues as they come up

-materiality is often a small fraction of the account being audited and planned procedures will be sufficiently precise to identify significant misstatement

-when errors identified additional testing is typically performed in account and related accounts

3. evaluate audit findings

-when evidence gathered auditor compares account level misstatements to tolerable misstatement

-aggregates misstatement from each account

-compares aggregate misstatement to overall materiality

-if accounts not misstated by more than tolerable misstatement and aggregate misstatement is less then overall materiality then conclude financial statements are fairly presented

-if not make adjustment

materiality

-accumulate misstatements except clearly trivial ones

-uncorrected misstatements

-all misstatements evaluated using dual method

uncorrected misstatements

-must be communicated to audit committee/those charged with governance

-auditor must evaluate whether they are material individually and material in combo with other misstatements

rollover method

-focuses on current year misstatements/reversals

-account is misstated by the error amount in the current year income statement

-correct the income statement-leave balance sheet misstated

iron curtain method

-focuses on all misstatements and correcting the cumulative effect of them

-account is misstated by error amount in current year balance sheet regardless of year misstatement arose

-correct balance sheet-corrects all misstatements

-leaves income stmt misstated-does not adjust prior year income stmts