ISA 320 - Audit Materiality Flashcards
ISA 320
MATERIALITY IN PLANNING & PERFORMING AN AUDIT
One of the objectives of the auditor in ISA 200 is to obtain reasonable assurance about WHETHER the FS as a whole are free from MATERIAL misstatement, whether due to fraud or error
FIRST STEP – Auditor must determine what is considered “MATERIAL”
Definition of materiality:
‘Misstatements including omissions, are considered to be MATERIAL IF they, individually or in aggregate, could REASONABLY BE EXPECTED TO INFLUENCE the economic decisions of USERS which are made on the basis of the FS.
The audit engagement partner will also use “what is material to users” TO INFLUENCE whether the aggregate of UNCORRECTED misstatements are material to warrant the audit report being modified.
ISA 320
MATERIALITY IN PLANNING & PERFORMING AN AUDIT
- Materiality in PLANNING the audit
- Materiality in PERFORMING the audit
- Materiality for particular Transactions, Account balances & Disclosures
- Trivial materiality
- Component materiality
ISA 320
Overall Materiality (Also known as: Materiality for the FS as a whole , Preliminary Materiality, Planning Materiality)
Purpose of setting overall materiality:
▪ To determine the size of misstatement that is material enough to influence the economic decisions of USERS.
▪ To determine performance materiality. (Performance materiality is lower than Overall Materiality)
▪ To determine a clearly trivial threshold for accumulating misstatements. (1 - 5% of overall materiality)
BENCHMARKS selected must be:
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APPROPRIATE (appropriate to nature of industry) &
NOT VOLATILE (If results are volatile, the auditor should use normalised PBT from continuing operations figure based on past results)
WHO determines which BENCHMARK the providers of finance & investors of THIS client company are focused on?
The Audit Engagement Partner
ISA 320
Performance Materiality
Purpose of setting performance materiality:
Performance materiality acts like a “safety buffer” to lower the risk of AGGREGATE uncorrected (Some misstatements, even those identified by the auditor, will not be corrected by client) AND undetected misstatements (There will always be misstatements which will not be discovered by the auditor since a 100% audit not done) being material for the overall financial statements
▪ Performance materiality is determined to guide the Nature, Extent & Timing of audit procedures. Transactions & balances of > performance materiality will:
- Be subject to substantive procedures (i.e. detailed testing)
- Require more audit evidence. (Bigger sample sizes)
- Require more precise timing of when audit procedures should be carried out.
How to calculate?
ISA 320 DOES NOT specify a specific methodology for determining Performance Materiality.
However, performance materiality is set at an amount less than the overall materiality.
(Perhaps, at 50% of Overall Materiality. This calculation is not mechanical, as it also involves professional judgment)
ISA 320
Performance Materiality for PARTICULAR transactions, balances & disclosures
Purpose of setting performance materiality for PARTICULAR transactions, account balances & disclosures:
A different materiality level is used to audit certain items BECAUSE
certain transactions, balances & disclosures could influence economic decision of users,
or it may be that particular balance or class of transaction have a HISTORY of material misstatements.
Example:
- Industry-specific data like research & development expenditure in a pharma audit client.
- An illegal act, non-compliance with loan covenants and statutory/regulatory reporting requirements.
- Management remuneration
- Transactions upon which bonuses are based
- Related party transactions.
- Significant management estimates or valuations.
How to calculate?
ISA 320 DOES NOT specify a specific methodology for determining this materiality.
Judgment must be applied to understand the needs users.
ISA 320
Trivial Materiality for PARTICULAR transactions, account balances & disclosures
Purpose of setting trivial materiality:
This will help the audit team decide WHAT SIZE of misstatements TO IGNORE & not accumulate in the Summary of Uncorrected Misstatements.
How to calculate?
Trivial materiality is usually 1% - 5% of Overall Materiality.
ISA 320
Component Materiality
Purpose of setting component materiality:
In a group audit, the group auditor is responsible for auditing the financial statements of the group as a whole, which includes the financial statements of individual companies within the group. The group auditor may set component materiality for each individual company within the group in order to determine the appropriate level of audit testing for that company.
There are several reasons why the group auditor might set component materiality for each individual company within the group:
- To ensure that the audit of the group’s financial statements is conducted in a consistent and systematic manner.
- To ensure that the audit is focused on those areas that are most likely to be material to the group’s financial statements as a whole.
- To help the group auditor assess the risk of material misstatement and allocate audit resources appropriately.
- To help the group auditor identify and address any material misstatements that may exist in the financial statements of individual companies within the group.
- Overall, setting component materiality helps the group auditor to conduct an effective and efficient audit of the group’s financial statements and provide reasonable assurance that the group financial statements are free from material misstatement.
How to calculate?
Method of calculation is the same as for Overall Materiality.
ISA 320
MATERIALITY - Revision as the Audit Progresses
Revision as the Audit Progresses
Materiality for the FS is not cast in stone.
The auditor shall revise materiality for the FS as a whole (in the event new information about client entity comes to light & risk assessment is updated OR if financial results are likely to be substantially different from the anticipated period end financial results that were used initially to determine materiality for the financial statements as a whole)
The auditor shall determine whether it is necessary to revise performance materiality,
and whether the Nature, Extent & Timing and extent of the further audit procedures remain appropriate.
Therefore at the overall review stage, EP to consider if OVERALL MATERIALITY needs to be revised & whether more FS items need to be audited.
ISA 320
MATERIALITY - Documentation
Documentation
The auditor shall include in the audit documentation the following amounts and the factors considered in their determination (i.e. to document the JUSTIFICATION):
- Overall Materiality
- Performance materiality
- Materiality for particular transactions & balances.
- Any revision of materiality as the audit progressed.
ISA 320 requires the auditor to STATE in audit working papers that they have considered whether materiality level should be revised & whether they have been revised.
