Set 1 - AU Chapter 5 Materiality

Question 1

What is step 1 when setting materiality?

Answer 1

Identifying users of the financial statements

Question 2

What is step 2 when setting materiality?

Answer 2

Identifying the users objectives

Question 3

In step 3, you determine the basis for materiality. What are the most common? There are 5.

Answer 3

Normalized income before taxes (most common in for-profit companies)
Total assets
Total revenues
Total expenses
Total equity

Question 4

For the basis in question 3 what are the common % threshold determined in step 4?

Answer 4

For profit: - 3-7% of normalized income before tax

• 1-3% of revenue or expenses
• 1-3% of total assets
• 3-5% of equity

Non-profit: - 1-3% of revenue or expenses
- 1-3% of total assets

Question 5

In step 5, the practitioner must determine if there are any unusual or non-recurring items that must be adjusted before applying the materiality threshold. What are some examples of this?

Answer 5

• unusual or non-recurring revenue or expenses
• special one-off management bonuses
• unusual gains/losses on disposal of PPE

After adjusting net income to take into account the above, this is then multiplied by materiality threshold in step 4.

Question 6

Step 6 is setting performance materiality. What is the typical range for this? When the risk of material misstatement is higher, is a lower or higher PM used?

Answer 6

60-80% of overall materiality determine in step 5. Lower.

Question 7

In Step 7, specific materiality is set. What is the purpose?

Answer 7

It is set if there are balances or classes or transactions where an amount less than overall materiality would influence or change decision of a known user. Practitioner can use a percentage of the accounts, as long as it is less than materiality.

Question 8

In step 8 specific performance materiality is set. When is this set? What is the threshold?

Answer 8

This is only set when there is a specific materiality in step 7. The threshold is 60-80% of the specific account or class balance. Again, 60% is if risk of RMM is high, 80% is if it is low.