AC414 CLASS NOTES
MATERIALITY
APRIL 2023
OUTLINE
1.
2.
3.
4.
Defining materiality
Determining which figures to use in calculating materiality
Calculating materiality
Practice questions
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Materiality
Materiality is considered throughout the audit.
When identifying and assessing the risks of material
misstatement
When determining the nature, timing and extent of
further audit procedures
When evaluating the effect of uncorrected misstatements
on the financial statements and the related audit report
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Defining materiality
Information is material if its omission, misstatement or non-disclosure
has the potential, individually or collectively to:
a. Influence the economic decision of users taken on the basis of the
financial report
b. Affect the discharge of accountability by the management or
governing body of the entity
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Accounting
materiality
Auditing
materiality
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Subjective
Relative
Nature of
Materiality
Quantitative
Qualitative
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Determining materiality when planning the audit
- Materiality level for the financial statements as a whole
- Materiality levels for particular classes of transactions and account
balances
- Amounts lower than materiality level or levels for purposes of
assessing risks and designing further audit procedures
- Considerations as the audit progresses
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• In planning the audit , the auditor makes judgements
about the size of misstatements that will be
considered material.
• The auditor considers:
the size,
the nature of any identified misstatements and
the circumstances of their occurrence.
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Planning Materiality
• Use of benchmarks
• Categories of reported income, e.g. profit before tax, total revenue, gross
profit and total expenses, total equity or net asset value
• Relevant financial data
1.Prior periods’ financial results and financial positions
2.The period-to-date financial results and financial positions
3.Budgets or forecasts for the current period,
4.Relevant changes of conditions in the industry or economic environment
• The financial statements on which the auditor is reporting
• SFP figures, SPL&OCI figures or both
• Percentage to be applied to the chosen benchmark
• 5-10% profit
• 1-2% total assets
• ½ - 1% revenue
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Performance materiality
• Performance materiality
amounts set by the auditor to reduce to an appropriately low level the
probability that the aggregate of uncorrected and undetected misstatements
could exceed materiality for the financial statements as a whole.
• Depends on
Nature of the entity
Auditor’s experience and professional judgement
The expectation of misstatement in the current period
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Materiality considerations as the audit progresses
“The auditor should revise the materiality level for
the financial statements as a whole, and the
materiality level for a particular class of
transactions and account balances if applicable, in
the event of becoming aware of information during
the audit that would have caused the auditor to
have determined a different materiality level or
levels initially”
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Documentation
The auditor shall include in the audit documentation the following
amounts and the factors considered in their determination:
a) Materiality for the financial statements as a whole.
b) If applicable, the materiality level or levels for particular classes of
transactions, account balances or disclosures
c) Performance materiality
d) Any revision of (a)–(c) as the audit progressed
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Practice question 1
1. Discuss materiality in the context of the preparation and
presentation of financial statements (4)
2. Explain the differences between using the concept of materiality at
the planning stage of the audit and at the evaluating stage of the
audit (2)
3. Identify five factors to be considered when quantifying “planning”
materiality (3)
4. Distinguish between planning materiality and performance
materiality (2)
(Graded Questions on Auditing)
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Practice question 2
The following relevant percentages have been calculated from the draft
financial statements of an audit client for the year ended 31 March
2021 (actual 2020)
Revenue
½%
1%
2021
$0.8m
$1.6m
2020
$0.7m
$1.4m
5%
10%
$0.1m
$0.2m
2020 (loss)
n/a
n/a
Total Assets
1%
2%
2021
$1.0m
2.1m
2020
$1.1m
$2.1m
Profit/(loss) before taxation
2021
Required
Determine materiality for the financial statements as a whole and justify the suitability of your assessment
(Graded questions on auditing)
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Practice question 3
E-Audit uses the following guidelines for the computation of planning materiality (i.e. the materiality figure to be used when planning
and performing the audit):
Indicator
Interval
Turnover
0.5% – 1%
Net profit before tax
5% – 10%
Total assets
1% – 2%
Equity
2% – 5%
The following is an extract of the unaudited and budgeted financial results of GAL as at 31 March 2017:
Item
Unaudited financial results
Budgeted financial results
Turnover
50 000 000
60 000 000
Gross profit
20 000 000
18 000 000
Expenses
10 000 000
15 000 000
Net income
18 000 000
25 000 000
Total assets
25 000 000
25 000 000
Total liabilities
15 000 000
15 000 000
Equity
10 000 000
10 000 000
Your audit team established that there were no material fluctuations in financial results from the prior to the current year and that
equity is not a suitable indicator. Finally, inherent risk was assessed as high.
Required
Describe the steps that should be followed by the auditor to calculate
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reasons. (10)
Practice question 4
You are a member of the team on the audit of Consumex Ltd, a listed company which sells a wide range of consumer goods. You and
other members of the team are currently discussing the materiality figure for the planning and performance of the current audit. As a
starting point you used the prior year’s planning materiality figures set for the various account balances and classes of transactions
with a clear understanding that these figures would probably be adjusted as the identification and assessment of the risk of material
misstatement and further audit procedures got underway. Before the discussion amongst team members got underway, Beckie Zulu,
a junior trainee posed the following question “When deciding on our planning materiality, is there a “cost/benefit” issue we should
be considering?”
During the identification and assessment of the risk of material misstatement, the following information was obtained.
1.
The company negotiated two large long term loans during the year. Both loans included loan covenants which require strict
adherence to specified liquidity ratios. The company has not had to contend with this in prior years. (3)
2.
The number of major transactions with related parties increased considerably during the year. (4)
3.
A charge of price fixing of certain consumables has been brought against Consumex Ltd and three other companies in the same
sector. The company’s legal council are not confident that the charge can be successfully defended, but that the penalty cannot
be estimated yet. (3)
4.
Halfway through the year the company relaxed its credit terms in an attempt to boost sales. The amount of credit made
available to customers was increased dramatically and repayment terms were extended. (4)
5.
The company started trading in derivatives for the first time in its history. (4)
6.
The automated (computerised) inventory control system, which had proved somewhat unreliable was substantially upgraded
just before the end of the prior financial year. Interim tests of controls conducted on the system by your computer audit
division found the upgraded system to be “very reliable, well designed and capable of producing a great deal of information
about the company’s inventory.” (3)
REQUIRED
a)
Respond to the question from Beckie Zulu. (4)
b)
Indicate whether the information in each of the points 1 to 6 above would increase or decrease (or have no affect on) the
planning (and performance) materiality figures from the prior year. Justify your decisions. (21)
(Graded questions on auditing)
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