Audit & Assurance: Materiality

Question 1

Steps in determining materiality

Answer 1

1. Identify USERS of financial statements.
2. Identify users’ OBJECTIVES
3. Determine the BASE for materiality
4. Identify the % threshold for materiality
5. Determine overall materiality
6. Determine performance materiality
7. Determine specific materiality
8. Determine specific performance materiality

Question 2

What is the most common basis for materiality in for-profit entities? Other common bases?

Answer 2

Normalized income before tax

Total assets
Total revenues
Total expenses
Total equity

Question 3

Examples of normalizing items that may have an impact on net income

Answer 3

Unusual or non-recurring revenue or expenses

Special management bonuses

Unusual gains or losses on disposition of PPE

Question 4

Performance materiality

Answer 4

Auditor focused

Usually 60-80% of overall materiality

Creates a cushion or safety buffer for the auditor

Question 5

Specific materiality

Answer 5

Used for specific risks and balances in sensitive audit areas

Question 6

T or F: materiality is based on risk

Answer 6

False.

The practitioner should not use risk when determining overall materiality.

Materiality is driven by the needs of the users of the company’s financial statements.

Question 7

When should the auditor consider materiality?

(a) during the planning phase of the audit
(b) throughout the entire audit
(c) when risk is assessed

Answer 7

(b) throughout the entire audit