6 - materiality and substantive audit procedures Flashcards
what is materiality?
inherent in accounting (true and fair view) and auditing (ISA200)
definition per ISA 320: Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. Judgements about materiality are made in the light of surrounding circumstances, and are affected by the size or nature of a misstatement, or a combination of both
thus no general rules prescribed, rather based on judgement in particular circumstances.
what are the steps in applying materiality?
planning extent of tests
- set material for financial statement
- determine performance materiality
evaluating results
- estimate total misstatement in segment
- estimate combined misstatement
- compare combined estimate with preliminary or revised judgement about materiality
what are the two types of likely misstatement in an audit?
- differences between mgment’s and auditor’s judgement about estimates of account balances
- projections of misstatements based on auditor’s test of a sample
when is the materiality for the financial statements as a whole set?
at the planning stage
how is materiality often stated? what other ways might it be stated?
as % of profits
because empirical support for importance of profit numbers to share price and investment decision making
may be set for other figs like total assets, or use accounts balances and adopt different materiality levels for different aspects of the audit
what are (typically) the three key steps in setting materiality level?
choosing an appropriate benchmark
determining the level of the benchmark
justifying the choices/explaining the judgement
what does ISA320 include as factors to consider when choosing a materiality benchmark? what are some appropriate benchmarks?
nature of entity and industry
whether users focus on particular items in the financial statements
relative volatility of benchmark
appropriate benchmarks:
profit before tax/normalised profit before tax, total income/total expenses, gross profit, total equity, net assets
how can an auditor determine the level of the materiality benchmark?
generally go off previous years, consider rises or falls in revenue die to exceptional orders, consider rises/drops in profit before tax.
what challenges should an auditor think about when justifying their choices about the materiality benchmark?
whether to set specific level of materiality for individual balances, classes of transactions or disclosures
short and long periods of account
what does the auditor need to consider/decide upon with regards to materiality?
auditors need to identify primary user group for audit report and opinion
assume users have a reasonable knowledge of business and accounting
at outset of audit - particularly during planning - auditor has to decide what level of error or mistatement could occur in financial statements before decsions of someone with these qualities would be influenced
might suggest setting materiality low as possible, but auditor’s judgement also balances cost implications (lower level = more evidence needed)
what are projected misstatements?
calculated by (misstatements in sampling/total sample)*(total population-specific items tested-sample). all in terms of £.
factual misstatements (misstatements actually found) and projected misstatements should be included on the summary of misstatements
what influences materiality level?
size (value) relative to balance
importance of heading - e.g. account balance being 40% of total assets more important, lower materiality level may be justified
nature (user relevance) - auditors may judge some balances more important.
auditor’s past experience - detection of misstatement in particular balance in past may lead to reducing materiality level.
trend in account balance - lower levels where balances have changed markedly from prio year or departed from trend.
how should errors be treated during the audit and at the evaluation stage?
during audit - errors on account balance should be looked at in aggregate, several immaterial errors may be material together.
evaluation stage - even if detected errors immaterial, does size and frequency suggest that together with undetected errors there is material misstatement?
what are the issues in closing accounts where materiality should normally be overridden because of specific disclosure needs?
required disclosures: even immaterial differences should be adjusted where there is a specific requirement for disclosure. e.g. companies act 2006 requirements for disclosures of director remuneration and capital commitments
improper disclosure of accounting policies: capacity to mislead user in overall appraisal
improper classifications: form of misrepresentation, e.g. including part of current tax charge in deferred tax.