Question :

What is the the purpose of allocating the preliminary judgment about materiality to balance sheet
accounts?
Answer :
The purpose is to help the auditor decide the appropriate evidence to accumulate for each account on
both the balance sheet and income statement. An aim of the allocation is to minimize audit costs
without sacrificing audit quality. Regardless of how the allocation is done, when the audit is
completed, the auditor must be confident that the combined misstatement in all accounts are less than
or equal to the preliminary (or revised) judgment about materiality.
Question :
How to estimate misstatement and compare with preliminary judgment?
Answer :
1. Set preliminary judgment about materiality
2. Allocate preliminary judgment about materiality to segments
3. Estimate total misstatement in segment
4. Estimate the combined misstatement
5. Compare combined estimate with preliminary or revised judgment about materiality
ALLOCATE

PRELIMINARY

JUDGMENT

ABOUT

MATERIALITY

TO

SEGMENTS (TOLERABLE MISSTATEMENT) The allocation of the preliminary

judgment about materiality to segments is necessary because auditors accumulate evidence by
segments rather than for the financial statements as a whole. If auditors have a preliminary
judgment about materiality for each segment, it helps them decide the appropriate audit
evidence to accumulate.
Auditors face three major difficulties in allocating materiality to balance sheet accounts:
1. Auditors expect certain accounts to have more misstatements than others.
2. Both overstatements and understatements must be considered.
3. Relative audit costs affect the allocation.