Materiality

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Materiality

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

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