Materiality

Definition

. Misstatements, including omissions, are considered to be material if they,

individually or in the aggregate, could reasonably be expected to influence
the economic decisions of users taken on the basis of the financial
statements

Judgement about materiality are made in light of surrounding circumstances,

and are affected by the size and nature of misstatement, or a combination of
both; and

Judgement about matters that are material to users of the financial

statements are based on a consideration of the common financial
information needs of users as a group.

PSA 320 par 2

Materiality

Definition:

Information is material if its omission or misstatement could influence the

economic decision of users taken on the basis of the financial statements.

Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement.
• Thus, materiality provides a threshold or cut-off point rather than being a
primary qualitative characteristic which information must have if it is to be
useful.

Financial Reporting Standard Council (FRSC)

Concept of Materiality:

The largest amount of misstatement that the auditor could tolerate

The smallest aggregate amount that could misstate the financial statement

Materiality therefore relates to:

⚫the significance of transactions

•balances and errors contained in the financial statements.

• threshold or cut-off point after which financial information becomes

relevant to the decision-making needs of the users.

Consideration of Materiality

Materiality should be considered by the auditor

Determining the nature, timing and scope of the audit engagement

Identifying and assessing the risks of material misstatement

Adjustments, revisions of audit plans

Features of Materiality

Involves both quantitative and qualitative considerations

Relative to size and particular circumstance of the entity

To determine what is material is a matter of professional judgment of the

auditor

In designing audit plan, the auditor should establish materiality level to

detect material misstatements

Even immaterial matters can have material effect in the Financial Statements

Features of Materiality

Materiality may be influenced by legal and regulatory requirements

In designing an audit plan, make a preliminary estimate of materiality for use

during the examination

Some matters are important for fair presentation while other matters are not
that important

The largest amount of misstatement that the auditor could tolerate in the
Financial Statement

The smallest aggregate amount that could misstate the Financial Statement
Features of Materiality

An error may not be material quantitatively but material qualitatively

Small amounts but collectively could have a material effect

Materiality refers to an amount or transaction that would influence the

decision of users

Materiality depends on the size of the item

It is a threshold point not a characteristic to be useful

The auditor’s determination of materiality is

•A matter of professional judgment,

•Affected by the auditor’s perception of the financial information needs of

the users of financial information.

The auditor can assume that users:

•Have knowledge of the business, economic and accounting activities of the

firm and will diligently study the information in the financial statement

•Understand that FS are prepared and audited to levels of materiality

•Recognize uncertainties that measurement used are based on

Estimates, judgment, forecasts •Make economic decision based on the
information in the financial statement

(PSA 320 par 4)

Use of Materiality

Planning and performing the audit

Evaluating effect of identified misstatements and uncorrected misstatements

Forming the opinion in the auditor’s report

Importance of materiality:

To determine the volume of evidence to be accumulated

Overall materiality

Based on financial statement as a whole

• The highest amount of misstatement without affecting the economic

decision of the users

• Financial Statements are interrelated

• Based on the common financial information needs of the users.

Percentage is often applied to a chosen benchmark as starting point

Different Levels of Materiality

(PSA 320 par 10)

Financial Statement level or overall materiality- materiality for the financial

statement as a whole

Specific materiality- materiality applied to classes of transactions, account

balances, disclosures

Performance materiality-scoping of financial statements line items to be

tested by the auditor to ensure that significant accounts are covered in the
audit testing (PSA 320 par 9)

Overall materiality

• Based on financial statement as a whole

• The highest amount of misstatement without affecting the economic

decision of the users

• Financial Statements are interrelated

• Based on the common financial information needs of the users.

Percentage is often applied to a chosen benchmark as starting point

Materiality Benchmarks

• The elements of financial statements

• Items which users tends to be focused

• Life cycle of the entity

• Economic environment which the entity operates

• Ownership structure and the way it is financed

Technical Benchmark

Reported income such as profit before tax, total revenue

• Gross profit and total expense

• Total equity or net asset value

• Total Assets

• Total Revenues

Profit before tax from continuing operations (for profit-oriented entities)

Average of three years’ net income before taxes

Starting Points

PSA does not require any range of percentages, based in actual practice

Income from continuing operations – 3% to 7%

. Assets 1% to 3%

Equity – 3% to 5%

. Revenues – 1% to 3%

Less than 5% immaterial & greater than 10% materiality

1% to 1.5% larger of total assets or revenue

Suggestion: ranges from 5% - 20% of the factor

Specific Materiality

Lesser amount than the overall materiality that may be relevant to users

• Refers to sensitive accounts in the financial statements or disclosures

Done by allocating the overall materiality to the respective account balances

Allows the auditor to determine audit procedures to each specific accounts

• Allocation is not provided in the standards and highly subjective

Specific Materiality

Factors affecting application of specific materiality:

Law, regulation or applicable reporting framework affect user’s expectations

on measurement or disclosures on accounts

Key disclosures in relation to industry it operates

• Certain aspect in the business that is separately disclosed in the financial

statements

Tolerable misstatement: The allocated materiality to an account

Performance Materiality

Definition (PSA 320 par 9)

The amount or amounts set by the auditor at less than materiality for the
financial statements as a whole to reduce to an appropriately low level the
probability that the aggregate of uncorrected and undetected misstatements
exceeds materiality for the financial statements as a whole. If applicable,
performance materiality also refers to the amount set by the auditor at less
than the materiality level or levels for particular classes of transactions,
account balances or disclosures

Performance Materiality

Margin of safety or buffer against undetected misstatement and uncorrected

errors
Consideration of immaterial items on the aggregate to cause misstatement
exceeding materiality level

Set at lower amount than the overall materiality and specific materiality

• To lower audit risk to an appropriately low level

Performance Materiality

Other pertinent matters on performance materiality

Not a simple mechanical calculation but an exercise of professional judgment

Affected by the auditor’s understanding of the entity

Updated during the execution of the auditor’s risk assessment procedures

Nature and extent of accumulated misstatements from past engagements

Required for an auditor to establish under PSA 320

Par 11

Steps in using Materiality

• Establish a preliminary judgement about materiality

• Determine tolerable misstatement

• Establish performance materiality

• Estimate likely misstatements and compare totals to the preliminary

judgement about materiality

WARNING!!!

NEVER MENTION THE LEVEL OF MATERIALITY TO THE CLIENT OR AUDITEE

OTHERWISE EVIDENCE COULD BE MANIPULATED BY THE MANAGEMENT

AUDIT PLAN

Detailed Audit Plan

Understanding the entity and its environment (PSA 315)

• Auditor’s response to assessed risk (PSA 330)

• Other planned audit procedures for compliance to PSA (various PSA)

The auditor shall update and change the overall audit strategy and the audit
plan as necessary during the course of the audit

Documentation

• The overall audit strategy

• The audit plan

Significant changes discovered during the audit engagement and the reasons
for such changes
Pre-engagement activities

Letter of engagement

Materiality level

Initial Audit Engagements

Considerations in initial audit engagements:

Acceptability of the client relationship and specific engagement

Communication with the previous auditor, if there is a change, in compliance

with ethical requirements

Review the previous auditor’s working paper but consider the ethical
requirements

Direction, Supervision and Review

Auditor plans the nature, timing, and extent of direction and supervision of
engagement and review their work

Direction and supervision:

Extent of instructions to team members on procedures to

Undertake
Supervising how procedures are undertaken

Review: to determine if members have conducted the procedures properly

and effectively

Nature & timing varies and dependent on:

Size and complexity of the entity

Area of the audit

Assessed risk of material misstatement

Capabilities and competence of individual team members

PSA 510 – Opening Balances

PSA 510 par 3

Objective of the auditor regarding opening balances whether:

Opening balances contain misstatement and affect current period’s financial

statement

Consistency in the application of appropriate accounting policies reflected in

the opening balances
Opening balances: those account balances that exist at the beginning of the
period (PSA 510 par 4)

Other Critical Matters in Engagement Planning

Application of Analytical Procedures

Establishment of an engagement or audit team

Consideration of work performed by others:

Predecessor auditor

Other CPA

Specialists

Use of client’s staff

Internal auditors

Assessment of going concern

Identification of related parties

Analytical Procedures

Involves analysis of significant ratios and trends, including the resulting

investigation of fluctuations and relationships that are inconsistent with other
relevant information or deviations from predicted amounts.
Importance: It helps the auditor in identifying unusual transactions and
events that may affect fair presentations of the FS and material
misstatements.

PSA 520 “Analytical procedures” requires the auditor to use analytical

procedures in the planning and overall review stages of the audit,

Substantive Analytical procedures:

• Existence of unusual transactions or events

•Amounts, ratios, and trends that might indicate matters that have financial
statement and audit implications

• Development of expectations about plausible relationships that are

reasonably expected to exist

•Ratios and trends should be compared with a certain

Benchmark

•Ratios and balance indications may contradict each other

Compare and investigate:

• Prior years’ Financial Statements

• Anticipated results such as budget forecasts (income & expense

performance)
•Industry averages

•Non-financial factors

•Typical relationships among Financial Statement balances

• Analysis of significant ratios and trends

• Changes in the industry in which the entity operates

• Changes in key personnel

• Observation and inspection

Establishment of an Audit Team

Matters to consider:

Qualification

Ability

Experienced and knowledgeable

• Varied in expertise

• Audit size and complexity

Continuity and rotation of personnel

Consideration of Work Performed by Other Auditors/Parties

To be considered:

• Involvement of other auditors in the audit components

• Involvement of experts

• Number of locations

Consideration of Work Performed by Other Auditors/Parties

• Predecessor Auditor

• Other CPA

• Specialists

• Use of Client Staff

• Internal Auditors

Assessment of Going Concern Assumptior

Financial
Operations

Loss of customers

Availability of capital and credit

Others Matters

DANGER OF COMMITING MANAGEMENT FRAUD

Non-compliance capital or statutory requirements

Legislations or government policy expecte

Adversely affect the entity

Identification of Related Parties

Related party: if one party has the ability to control the other part or exercise
significant influence over the other party in making financial and operations
decisions

Examples of related party transactions:

Sales or purchase transactions between parent company and subsidiary

Cash advances between branches

Inventory warehousing among offices within the holding company

Foreign currency transactions between offices

Intercompany loans :significant transactions with related parties

Client’s Legal Obligation

Changes to articles of incorporation

Minutes of meeting

Significant contracts executed during the year

Major agreements or contracts

Current situation and future plans

Authorization of dividends

Inquiries into the entity’s operations or financial results by regulatory or

government bodies.

Pending litigation and contingent liabilitie

Scheduling of Work

• Deadline
• Ability of the audit staff

• Cost

• Other audit clients

Manpower Availability

Audit Program

Definitions

• Set of instructions or manuals to assistants or the audit team as a mean to

control the proper execution of the work. A program sets out the nature,
timing and extent of the planned audit procedures required to implement the
overall audit plan.

• A detailed list of procedures to be performed in an audit.

• A list of audit procedures to be performed so that the auditor will have

evidence as a basis for expressing an opinion on the financial statements

Audit Program

Types of Audit Program

Standard All-Purpose Audit Program

Tailor-Made Audit Program

Modified Standard Form

Preparation of the Time Budget

Definition

An estimated total hours to finish the audit engagement

Based on information obtained in understanding the client

• Allocated to work schedules indicating who, what to do, and length of time

• Basis for determining fees

• Used to measure efficiency of staff

• Indicates progress of the engagement

Preparation of the Time Budget

Factors to consider:

• the client’s size as indicated by sales, number of employees, branches,

offices

• location of client facilities

Anticipated accounting and auditing problems

Competence and experience of staff available

Personnel Assignment

PSA 220 par 8 to 25

The auditor, and assistants with supervisory responsibilities, will consider the
professional competence of assistants performing work delegated to them
when deciding the extent of direction, supervision and review appropriate for
each assistant