Chapter 10
Audit Materiality
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Key to chapter content ICONS
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CHAPTER 10:
Audit Materiality
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Concept
Definition
Information is material if:
its omission or misstatement
could influence the decisions of primary users
taken on the basis of the financial statements.
Materiality depends on the nature and/or size of the items to
which the information relates.
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Performance Materiality
Definition
Materiality set by the auditor at less than materiality for the
financial statements as a whole:
to reduce to an appropriately low level
the probability that the aggregate of uncorrected and
undetected misstatements
exceeds materiality for the financial statements as a
whole.
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Basic Principles
Auditor must exercise professional judgment to determine
what is material based on:
̶ understanding of the entity and its environment;
̶ the entity’s financial results and disclosures; and
̶ the requirements of the users of the financial
statements.
Materiality may be quantitative or qualitative
Must consider cumulative impact
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Levels of Materiality
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Performance Materiality Factors
The determination of performance materiality draws on:
the nature of the entity;
the auditor's experience;
professional judgment; and
the expectation of misstatements in the current period.
The aggregate of unadjusted immaterial misstatements must
be compared with performance materiality to ensure that the
aggregate is not material.
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Qualitative materiality
Comparison to benchmarks, including:
IFRS Accounting Standard disclosure requirements
Statutory disclosure requirements
Deciding whether a disclosure is material (especially for
estimated matters) requires professional judgment.
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Relevance to the Audit
Evaluating Planning the
misstatements audit
Determining
Evaluating
audit
results
procedures
Performing
audit
procedures
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Quantitative Materiality (Amounts)
Financial Statement Level Assertion Level
Compare item in relation to financial Compare an item to a category
statements as a whole. For example:
revenue; May be established as a set figure or as a
profit before taxation; percentage of a total.
total assets;
capital and reserves.
Consider the elements of the financial Example: an error of $50,000 may be
statements (e.g. a different materiality level considered material to inventory, but may
for the statement of profit or loss and the not be material to the statement of financial
statement of financial position). position if inventory as a whole is not a
material item.
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Quantitative Materiality (Amounts)
Precise Determination Use of Opinion/Judgment
(100% accuracy required)
For example, directors' For example, receivables
emoluments and share capital. allowance, contingent liabilities
and asset useful lives.
Any error (however small) may Depreciation expense based on
be considered material and five years may be material to profit
adjusted, especially as the and loss, but if based on six years
precise amount must be it may not be: five or six years is a
disclosed by law. matter of opinion and judgment.
Both could be equally acceptable.
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Qualitative Materiality (Nature)
Misstatements are more likely to be considered material when they:
Affect trends in profitability or change a loss into profit
Affect compliance with loan covenants, etc
Increase management compensation
Indicate a pattern of management bias
Involve fraud
Affect significant financial statement elements.
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Materiality in
Audit Planning
Risk assessment
• Nature
• Timing
• Extent
Audit Risks of
procedures material
• Nature misstatement
• Timing • Identify
• Extent • Assess
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Materiality in Audit Planning
Benchmarks:
5–10% net profit before taxation
1–2% total assets
½–1% revenue
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Activity: Planning Materiality
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Answer to activity: Planning Materiality (a)
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Answer to activity: Planning Materiality (b)
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Materiality in Audit Work
All matters identifies as material must be tested in detail.
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Activity: Trade Receivables
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Answer to activity: Trade Receivables
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Relationship of Materiality with Audit Risk
The relationship between materiality and audit risk is “inverse”:
Audit risk
Materiality
Auditor reduces audit risk by reducing detection risk:
Modifying the nature, timing and extent of planned substantive
procedures (increase).
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Revision as the Audit Progresses
Information obtained and evidence gathered as the audit
progresses, may require revision of the amount(s)
determined initially.
The auditor must consider effect on new information on the
performance materiality and the nature, timing and extent of
further audit procedures
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Chapter 10: Summary
Materiality expresses the relative significance or importance of a
particular matter to the financial statements as a whole
Performance materiality (set at less than materiality for the financial
statements) is used in planning and performing an audit
Factors affecting materiality include: economic decisions of users,
professional judgment, quantitative amounts and qualitative aspects
Overall materiality is a matter of professional judgment based initially
on a percentage applied to a chosen benchmark
All material matters must be subject to substantive audit procedures
There is an "inverse" relationship between audit risk and materiality
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Thank you
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