Ch.5 Materiality Flashcards
What is the concept of materiality?
IT considers the transactions, amounts, types of errors, and how it will influence the relevance and reliability of information for decision making.
Materiality is important in all stages of the audit and can be changed throughout the audit
What are the steps to determine materiality?
- Identify the users of the financial statements
- Identify the users’ objectives
- Determine the base for materiality
- Identify the percentage threshold for materiality
- Determine the overall materiality
- Determine performance materiality
- Determine specific materiality
- Determine specific performance materiality
What are some commun users you may expect to use financial statements?
lenders
shareholders
potential investors
management
What are the different bases you can use for materiality? And how do you determine which one is best for the client?
You use the user’s objective to determine materiality that is most appropriate.
For-profits, the most common is net income (profitability), but you can use revenue is they’re in a loss position or earnings are volatile.
NPO - expenses or assets if they’re more concerned with donor contributions
What are the different percentage thresholds for materiality?
For-profit
3%- 7% - normalized income before tax
1% - 3% of rev or exp
1% - 3% of total assets
3% - 5% of equity
NPO
1% - 3% of revenues or exp
1 - 3% of total assets
CAS will not tell you percentages, but use your professional judgement. Consider what information users are sentitive to (for misstatement) - this will drive what materiality threshold to use.
Look at objectives for what base to use - conclude on the base and threshold and link back to objectives when discussing within 1-2 sentences
How do you determine OM?
Once you select a base and threshold, you then normalize or adjust the base for unusual or non-recurring items.
After you apply the threshold, and round to the nearest hundred or thousand based on the users needs.
How do you determine PM?
Auditor considers the amount of audit work required to be sufficient audit evidence and it ranges from 60% - 75% of OM
PM creates a cushion or buffer that ensures that any unidentified misstatements are individually identified immaterial misstatements (aggregated) does not exceed materiality.
When RMM is high, PM threshold is low so that it is more sensitive to misstatements
How do you determine specific materiality?
This is set if there are balances or classes of transactions where if there is an error less than OM, it would still influence or change the decision of a user.
This deals with specific risks and balances around sensitive FSLIs.
For example, if there is a contingency, or a rules in a contract a comapny can’t exceed % inventory or AR, they may set an SM for these accounts since the bank would look at these two accounts.
Nothing is said about threshold - maybe use something less than OM? Like 50% of OM?
How do you determine specific performance materiality
This is similar to PM but instead of basing off OM, it’s based off of SM.
Use 60% - 75% of SM
