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  • 1. Materiality
    Tisa Madson
    Kelly Purdy
    SiJia Pang
    Yihong You
  • 2. Auditing Standards
    PCAOB
    AS 11
    AU 312
    Consideration of Materiality in Planning and Performing an Audit
    AICPA
    SAS no. 107
    Audit Risk and Materiality in Conducting an Audit
    ISA 320
    Materiality in Planning and Performing an Audit
  • 3. Definition
    Materiality is the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
    -FASB’s Statement of Financial Accounting Concepts No. 2 “Qualitative Characteristics of Accounting Information”
  • 4. Considering Materiality
    Auditor exercises professional judgment
    Materiality is assessed in terms of a misstatement’s potential effect on a reasonable user
  • 5. The Reasonable User
    • Have an appropriate knowledge of business and economic activities and
    accounting and a willingness to study the information in the financial
    statements with an appropriate diligence.
    • Understand that financial statements are prepared and audited to levels of
    materiality.
    • Recognize the uncertainties inherent in the measurement of amounts
    based on the use of estimates, judgment, and the consideration of future
    events.
    • Make appropriate economic decisions on the basis of the information in
    the financial statements
  • 6. Three-Step Process
    Step 1: Determine a materiality level for the overall financial statements
    Step 2: Determine Tolerable Misstatement
    Step 3: Evaluate Audit Findings
  • 7. Step 1: Planning Materiality
    Planning Materiality- Maximum amount by which the auditor believes the financial statements could be misstated and still not effect the decisions of users
    Materiality is relative
    Use benchmarks
  • 8. Benchmarks
    Rule of thumb- 5%
    Profit before tax from cont. ops
    Total revenue
    Net asset value
  • 9. Qualitative Factors
    Material misstatement in prior years
    Small amounts may violate covenants in a loan agreement
    Small amounts may cause entity to miss forecasted revenue or earnings
  • 10. Step 2: Determine Tolerable Misstatement
    Tolerable Misstatement is the amount of planning materiality that is allocated to an account or class of transactions.
    Set tolerable misstatements between 50 and 75 percent of planning materiality.
    Establish a scope for the audit process for individual account balances or class of transactions.
  • 11. The Safety Net
    Financial statement materiality serves as a safety net
    IF
    Individual misstatements are less than tolerable misstatement, but aggregate misstatements are greater than planning materiality:
    Auditor will need to perform more testing
    Audit client needs to adjust the financial statements
    And/or the auditor issues a qualified or adverse opinion
  • 12. Step3: Evaluate Audit Findings
    Determine the likely misstatement
    Aggregate misstatements from accounts
    Compare aggregate misstatement to the planning materiality
  • 13. Likely misstatement
    Closest reasonable estimate
    The difference between recorded amount and the amount at the closest end of the auditor’s range
  • 14. Aggregate misstatement
    Consider the effect of misstatements not adjusted in the prior period
    Planning materiality may differ from the materiality used in evaluating
  • 15. Comparison
    If less than planning materiality, fairly presented
    If more than planning materiality, request the client adjust the financial statement
  • 16. Review
    1st Determine Planning Materiality
    Usually 5% of pre-tax net income
    2nd Determine the tolerable misstatement
    50-75% of planning materiality for each account
    3rd Evaluate
    If greater than planning materiality
    Client adjusts financial statements
    Auditor may render an adverse opinion
  • 17. Source
    Messier William, Steven Glover and Douglas Prawitt. Auditing and Assurance Services. New York: McGraw-Hill/Irwin, 2010.