Ch. 5 Materiality

Question 1

Materiality

Answer 1

In Step 1 = Planning
But also in steps 2 and 3
recognizes that transactions, amounts, or certain types of errors, either individually or in the aggregate, directly influence the relevance and reliability of information for decision-making purposes

Question 2

Step 1

Answer 2

Identify the users of the financial statements
identifying the significant users of the financial statements. Users will vary based on the organization’s circumstances

Question 3

Step 2

Answer 3

Identify the users’ objectives
gain an understanding of the objectives and sensitivities of all of the significant users of the financial statements from step 1

Question 4

Step 3

Answer 4

Determine the base for materiality
The most common bases, otherwise known as benchmarks of materiality, are:
• normalized income before tax (this is the most common case for for-profit entities)
• total assets
• total revenues
• total expenses
• total equity

Question 5

Step 4

Answer 5

Identify the percentage threshold for materiality
CAS 320 does not specify exact percentages, but it does indicate that professional judgment should be applied.
For-profit entities:
• 3% to 7% of normalized income before tax
• 1% to 3% of revenues or expenses
• 1% to 3% of total assets
• 3% to 5% of equity
Not-for-profit entities:
• 1% to 3% of revenues or expenses
• 1% to 3% of total assets
User very sensitive to misstatement = lower end %
ALWAYS consider user and user objective

Question 6

Step 5

Answer 6

Determine overall materiality
must determine, based on their understanding of the client, if there are any unusual or non-recurring items that may need to be normalized or adjusted for
• unusual or non-recurring revenue or expenses
• special management bonuses
• unusual gains or losses on the disposition of PPE

Question 7

Step 6

Answer 7

Determine performance materiality
the practitioner considers the amount of audit work required to ensure that the identified and potential unidentified misstatements will not exceed overall materiality
PM to PEG 60% to 80% x overall materiality

Question 8

Step 7

Answer 8

Specific Materiality
SM is set if there are balances or classes of transactions where an amount less than overall materiality would influence or change the decision of a known user

Question 9

Step 8

Answer 9

Setting SPM, the practitioner considers the amount of audit work required to ensure that the identified and potential unidentified misstatements will not exceed SM.
based on what is required to reduce the risk of material misstatement (RMM) to an appropriately low level

Question 10

PM

Answer 10

PM is an amount less than the overall materiality
PM is set by the auditor with the objective of reducing the likelihood of undetected material misstatements and the audit risk to an acceptably low level