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Auditing and assurance

Auditing and assurance. Lecture 9a The Materiality Concept ISA 320* * Refer to slide 10. Materiality.

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Auditing and assurance

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  1. Auditing and assurance Lecture 9a The Materiality Concept ISA 320* * Refer to slide 10

  2. Materiality • “Information is material if its omission or misstatement could influence the economic decisions 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 cutoff point” IAASB, Framework, 2006;APB, Glossary of Terms, 2008

  3. Materiality (cont.) • ‘The auditor considers whether the effect of identified uncorrected misstatements, both individually and in the aggregate, is material to the financial statements taken as a whole’ • ‘The auditor considers the risk of material misstatement at two levels: the overall financial statement level and in relation to classes of transactions, account balances, and disclosures and the related assertions’ ISA (UK and Ireland) 200 (2006) (S.17)

  4. Materiality (cont.) • Materiality must be considered: • when planning - 'planning materiality‘ • The auditor considers what would make the FS’s materially misstated • Then plans suitable types and the extent of audit procedures • To reduce ‘Audit risk’ – Later in lecture

  5. Materiality (cont.) • when evaluatingthe effect of misstatements - 'final materiality’ • As the audit progresses the auditor may decide the initial materiality levels decided at the planning stage were inappropriate and adjust the plan ISA (UK and Ireland) 320 (ss.8-11)

  6. Materiality (cont.) • Practical bases - Quantitative • ‘Assertions’ • How much misstatement (in value) is acceptable? • 1p? • £1m?!

  7. Materiality (cont.) • 10% of profit before taxation (PBT) was the favourite determinate used for materiality (1999) • However the following methods are also used in large audit practices to calculate materiality: • 5 - 10% of PBT • 5 - 10% of current assets • 5 - 10% of current liabilities • ½ - 2% of total assets • ½ - 2% of turnover • 1 - 5% of equity

  8. Materiality (cont.) • Practical bases – Qualitative • Any of the following that might mislead the reader of the FS’s: • Any irregularity or intentional misstatement • Matters that affect contractual obligations • Matters that affect trends (f.e. earnings) • Correct narrative descriptions (f.e. policies) • Pending fines from regulatory violation

  9. Materiality (cont.) • The auditor will also consider materiality in terms of internal controls • How many times can an internal control be NOT complied with before the system is regarded as weak? • An example would be the omission of a manager’s authorisation on a purchase order • 0?, 1?, 12?... (more on ‘IC testing’ later…)

  10. Further reading • Note that a revised ISA 320 - ‘Materiality in Planning and Performing an Audit’ - will come into effect from 15th. December, 2009. • This is of interest, but will not be incorporated into the course until September 2010 • The course will follow the current set text for 2009-10

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