Materiality

Question 1

Steps to determining materiality

Answer 1

1. Identify the users
2. Identify user objectives
3. Determine the base for materiality
4. Identity the % threshold for materiality
5. Determine overall materiality
6. Determine performance materiality 60%-80%
7. Determine specific materiality
8. Determine specific performance materiality

Question 2

Determining the base for materiality

Answer 2

Consider only user concerns not risk - state this in answer
Common bases are:
• normalized income before tax (this is the most common case for for-profit entities)
• total assets
• total revenues
• total expenses
• total equity

Question 3

% thresholds for materiality

Answer 3

Consider only user concerns
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

Question 4

What is overall materiality based on

Answer 4

Adjust for any unusual or non-recurring items that may need to be normalized
• unusual or non-recurring revenue or expenses
• special management bonuses
• unusual gains or losses on the disposition of property, plant, and equipment

Once the normalized base is determined, the threshold is applied.

Question 5

What is performance materiality based on

Answer 5

When setting PM, consider the amount of audit work required to ensure that the identified and potential unidentified misstatements will not exceed overall materiality. - State this in answer

60% to 80% of overall materiality

When the risk of a material misstatement is higher, a PM threshold at the lower end of the range is generally selected

Question 6

What is specific materiality based on

Answer 6

Consider only user concerns
(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.

Can use a % of the account that the user is concerned about, as long as the amount is less than overall materiality.

Question 7

What is specific performance materiality based on

Answer 7

SPM at the class of transaction or account balance level is set at a lower level than both overall materiality and SM to reduce the risk of RMM to an appropriately low level.

Consider the amount of audit work required to ensure that the identified and potential unidentified misstatements will not exceed SM. SPM is required only when SM has been set for an account or group of accounts.