Assurance - Planning - Materiality

Question 1

What is materiality?

Answer 1

Part of the developing plam “M” in RAMP
- The threshold above which missing or incorrect information in F/S is considered to have an impact on decision-making for user
- Have certain types of error, individually or in error

Question 2

What is required when considering materiality for auditors

Answer 2

Materiality requires professional judgment with quant and qual factors
If materiality is low - Not possible to examine 100% of transaction
If it too high - may not examine F/S elements that are significant to the entity

Question 3

What are the 8 steps to calculate materiality

Answer 3

Step 1 - Identify the user of the F/S
Step 2 - Identify the objective
Step 3 - Determine the benchmark for materiality
Step 4 - Identify the % threshold for materiality
Step 5 - Calculate overall materiality
Step 6 - Calculate performance materiality
Step 7 - Calculate specific materiality (if applicable)
Step 8 - Calculate specific performance materiality (if applicable)

Question 4

How are users identified when determining materiality

Answer 4

• The users of F/S vary based on circumstances
  Ex. Difference between profit and NFP
  Ex. Lenders, shareholders, creditors, potential investor

Question 5

Explain what the user’s objectives are when considering materiality

Answer 5

• The objective of users is to gain an understanding of the objective and sensitivity of all significant users of the F/S
• They monitor financial leverage, liquidity, covenant, asset valuation, and debt coverage ratio

Question 6

How do auditors determine the benchmark to be used?

Answer 6

• The auditors should determine the benchmark that the user would be most concerned with
• CAS 320 - does not provide specific guidance on a benchmark that should be chosen
  Ex. Profit - main concern would be profitability
  Ex. Normalized profit before taxes, total asset, total equity, total revenue, total expenses

Question 7

How do you determine the materiality threshold?

Answer 7

Profit entities: 3-7% normalized profit before taxes
1-3% of revenue and expenses
1-3% total asset
3-5% equity
Non-profit entities - 1-3% of revenue and expenses
1-3% of total asset
- Important to consider users and their objective

Question 8

How do you calculate the overall materiality?

Answer 8

• For unusual or non-recurring items - items from financial reporting issues are to be removed to represent the normal course of operation
  Ex. revenue and expenses, special management bonuses, unusual gain or loss on disposition of PPE
• Normalize the benchmark is determined, the threshold is applied

Question 9

When and how do you calculate performance, specific and specific performance materiality?

Answer 9

Performance materiality
- The auditors consider the amount of audit work to ensure that the identified and potentially unidentified
- The suggested percentage threshold is between 60-75% of overall materiality
- Calculating PM requires professional judgment

Specific materiality (if applicable)
- it is not commonly calculated in audit, Only has a set of classes of transaction where an amount is less than overall materiality
- It Establish professional judgement

Specific performance materiality
- It is calculated to reduce the RMM to an appropriately low level. SPM at class of transaction or account balance level is set at a lower level

Question 10

Explain the relationship between materiality and material misstatement

Answer 10

• The timing, nature, and extent of audit work performed. RMM is high, auditor should not lower materiality SM
• The RMM is low, the auditor should not increase materiality auditors should increase the quality and quantity of audit evidence to reduce RMM