Materiality

Materiality

• 1.
  MaterialityTisa MadsonKelly PurdySiJiaPangYihong You
• 2.
  Auditing StandardsPCAOBAS 11AU312Consideration of Materiality in Planning and Performing an Audit AICPASAS no. 107Audit Risk and Materiality in Conducting an AuditISA 320Materiality in Planning and Performing an Audit
• 3.
  Definition Materiality is the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement. -FASB’s Statement of Financial Accounting Concepts No. 2 “Qualitative Characteristics of Accounting Information”
• 4.
  Considering MaterialityAuditor exercisesprofessional judgmentMateriality is assessed in terms of a misstatement’s potential effect on a reasonable user
• 5.
  The Reasonable User• Have an appropriate knowledge of business and economic activities andaccounting and a willingness to study the information in the financialstatements with an appropriate diligence.• Understand that financial statements are prepared and audited to levels ofmateriality.• Recognize the uncertainties inherent in the measurement of amountsbased on the use of estimates, judgment, and the consideration of futureevents.• Make appropriate economic decisions on the basis of the information inthe financial statements
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  Three-Step Process Step1: Determine a materiality level for the overall financial statementsStep 2: Determine Tolerable MisstatementStep 3: Evaluate Audit Findings
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  Step 1: PlanningMaterialityPlanning Materiality- Maximum amount by which the auditor believes the financial statements could be misstated and still not effect the decisions of usersMateriality is relativeUse benchmarks
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  BenchmarksRule of thumb-5%Profit before tax from cont. opsTotal revenueNet asset value
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  Qualitative FactorsMaterial misstatementin prior yearsSmall amounts may violate covenants in a loan agreementSmall amounts may cause entity to miss forecasted revenue or earnings
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  Step 2: DetermineTolerable MisstatementTolerable Misstatement is the amount of planning materiality that is allocated to an account or class of transactions.Set tolerable misstatements between 50 and 75 percent of planning materiality. Establish a scope for the audit process for individual account balances or class of transactions.
• 11.
  The Safety NetFinancialstatement materiality serves as a safety netIFIndividual misstatements are less than tolerable misstatement, but aggregate misstatements are greater than planning materiality:Auditor will need to perform more testingAudit client needs to adjust the financial statementsAnd/or the auditor issues a qualified or adverse opinion
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  Step3: Evaluate AuditFindingsDetermine the likely misstatement Aggregate misstatements from accountsCompare aggregate misstatement to the planning materiality
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  Likely misstatementClosest reasonableestimateThe difference between recorded amount and the amount at the closest end of the auditor’s range
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  Aggregate misstatementConsider theeffect of misstatements not adjusted in the prior periodPlanning materiality may differ from the materiality used in evaluating
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  ComparisonIf less thanplanning materiality, fairly presentedIf more than planning materiality, request the client adjust the financial statement
• 16.
  Review1st Determine PlanningMaterialityUsually 5% of pre-tax net income2nd Determine the tolerable misstatement50-75% of planning materiality for each account 3rd EvaluateIf greater than planning materialityClient adjusts financial statementsAuditor may render an adverse opinion
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  SourceMessier William, StevenGlover and Douglas Prawitt. Auditing and Assurance Services. New York: McGraw-Hill/Irwin, 2010.