Assignment 2

Name: M. Talha Ahmad

Class: M.com Evening

Roll No: L-1302

Submitted to: Sir Imad-ud-Din Akbar

Contents
1.Materiality................................................................................................................................................2
2.Method of Calculating Materiality............................................................................................................2
2.1 Single Rule.........................................................................................................................................2
2.3 Variable size rule...............................................................................................................................2
3.Ranges......................................................................................................................................................2

QUESTION
Thresholds of materiality in audit and which factors considered while
evaluating the materiality. Explain the ranges of revenue profit after tax gross
assets and net assets
1.Materiality
The materiality threshold in audits refers to the benchmark used to obtain reasonable
assurance that an audit does not detect any material misstatement that can significantly
impact the usability of financial statements. It is not feasible to test and verify every
transaction and financial record, so the materiality threshold is important to save resources,
yet still completes the objective of the audit.

2.Method of Calculating Materiality

The International Accounting Standards Board (IASB) has refrained from giving quantitative
guidance and standards regarding the calculation of materiality. Since there is no
benchmark or formula, it is very subjective at the discretion of the auditor.
However, some academic bodies have developed calculation method.
2.1 Single Rule
 5% of pre-tax income
 5% of total assets
 1% of shareholders’ equity
 1% of total revenue

2.3 Variable size rule

2% to 5% of gross profit (if less than $20,000)
1% to 2% of gross profit (if gross profit is more than $20,000 but less than $1,000,000)
5% to 1% of gross profit (if gross profit is more than $1,000,000 but less than
$100,000,000
5% of gross profit (if gross profit is more than $100,000,000)
There are also blended methods that combine some of the methods and using

3.Ranges
This published paper gives methods for ranges of calculating materiality. Depending on
the audit risk, auditors will select different values inside these ranges.
 5% to 10% of total revenue
 1% to 2% of total assets
 1% to 2% of gross profit
 2% to 5% of shareholders’ equity
 5% to 10% of net income
CASE STUDY
ISA 550 Related Party CASE STUDY
•The draft statement of financial position of ABC Company includes an

amount of Rs. 300,000 owed by DE Company. The total assets of

ABC Company are Rs. 200
•The auditor has obtained the following audit evidence:
•DE Company is controlled by the chairman of ABC Company, who is its
majority shareholder
•The draft financial statements of ABC Company do not provide any
disclosures about the Rs. 300,000 transaction, on the grounds that it is
immaterial.
•There is no information about the nature of the transaction, but the Rs. 300,000
had been included in receivables at the end of the previous financial year.
Required
•What further measures should the auditor take? Furnish your

ANSWER:
The auditor should confirm that DE is a related party by confirming relationship of parties. It
does not appear to be material in terms of monitory value of the transaction. But the
nature of transaction must also be judged. The chainman must be consulted in this matter
and a written representation must be obtained. Auditor should review the minutes of board
meeting.
The auditor should notify the management about need for disclosure of related party
transaction. The disclosure should give information regarding nature, amount and any
allowance required by the company in case of recoverable amount by the company.