Chapter 10

Audit Materiality

© ACCA 1
Key to chapter content ICONS

© ACCA 2
CHAPTER 10:
Audit Materiality

© ACCA 3
Concept

Definition
Information is material if:

§ its omission or misstatement

§ could influence the decisions of primary users
§ taken on the basis of the financial statements.

Materiality depends on the nature and/or size of the items to

which the information relates.
© ACCA 4
Performance Materiality

Definition
Materiality 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.
© ACCA 5
Basic Principles

Auditor must exercise professional judgment to determine

what is material based on:

§ understanding of the entity and its environment;

§ the entity’s financial results and disclosures; and
§ the requirements of the users of the financial statements.

© ACCA 6
Basic Principles

§ Materiality may be quantitative or qualitative (related to

disclosures)

§ The cumulative impact of amounts and disclosures must

be considered.

© ACCA 7
Levels of Materiality

© ACCA 8
Performance Materiality Factors
The determination of performance materiality draws on:

§ the nature of the entity;

§ the auditor's experience;
§ the use of professional judgment; and
§ the expectation of misstatements in the current period.

The aggregate of unadjusted immaterial misstatements must

be compared with performance materiality to ensure that the
aggregate is not material.

© ACCA 9
Qualitative materiality

Comparison to benchmarks, including:

§ IFRS disclosure requirements

§ Listing disclosure rules

Deciding whether a disclosure is material (especially for

estimated matters) requires professional judgement.

© ACCA 10
Relevance to the Audit
Evaluating Planning the
misstatements audit

Determining
Evaluating audit
results
procedures

Performing
audit
procedures
© ACCA 11
Quantitative Materiality (Amounts)
Financial Statement Level Assertion Level
Compare item in relation to financial Compare an item to a category
statements as a whole. For example:
• revenue; May be established as a set figure or as a
• profit before taxation; percentage of a total.
• total assets;
• capital and reserves.

Consider the elements of the financial Example: an error of $50,000 may be

statements (e.g. a different materiality level considered material to inventory, but may
for the statement of profit or loss and the not be material to the statement of financial
statement of financial position). position if inventory as a whole is not a
material item.

© ACCA 12
Quantitative Materiality (Amounts)
Precise Determination Use of Opinion/Judgment
(100% accuracy required)
For example, directors' For example, receivables
emoluments and share capital. allowance, contingent liabilities
and asset useful lives.
Any error (however small) may Depreciation expense based on
be considered material and five years may be material to profit
adjusted, especially as the and loss, but if based on six years
precise amount must be it may not be: five or six years is a
disclosed by law. matter of opinion and judgment.
Both could be equally acceptable.

© ACCA 13
Qualitative Materiality (Nature)

The nature of a misstatement must be considered when determining

whether the misstatement is material.

§ Affect trends in profitability or mask a change in trend, or change a

loss into profit;
§ Affect compliance with loan covenants, contracts or regulatory
provisions;
§ Increase management compensation or indicate a pattern of
management bias;
§ Involve fraud;
§ Affect significant financial statement elements.

© ACCA 14
Materiality in Audit Planning

Risk assessment
• Nature
• Timing
• Extent

Audit Risks of
procedures material
• Nature misstatement
• Timing • Identify
• Extent • Assess

© ACCA 15
Materiality in Audit Planning

Benchmarks:

§ 5–10% net profit before taxation

§ 1–2% net assets
§ ½–1% total assets
§ ½–1% revenue

© ACCA 16
Activity: Planning Materiality

© ACCA 17
Answer to activity: Planning Materiality (b)

© ACCA 18
Answer to activity: Planning Materiality (a)

© ACCA 19
Materiality in Audit Work

All matters identifies as material must be tested in detail.

© ACCA 20
Activity: Trade Receivables

© ACCA 21
Answer to activity: Trade Receivables

© ACCA 22
 Relationship of Materiality with Audit Risk
The relationship between materiality and audit risk is “inverse”:

Audit risk

Materiality
Auditor reduces audit risk by reducing detection risk:
Modifying the nature, timing and extent of planned substantive
procedures (increase).
© ACCA 23
Revision as the Audit Progresses

Information obtained and evidence gathered as the audit

progresses, may require revision of the amount(s)
determined initially.

The auditor must consider effect on new information on the

performance materiality and the nature, timing and extent of
further audit procedures

© ACCA 24
 Chapter 10: Summary
§ Materiality expresses the relative significance or importance of a
particular matter to the financial statements as a whole.
§ Performance materiality (set at less than materiality for the financial
statements) is used in planning and performing an audit.
§ Factors affecting materiality include: economic decisions of users,
professional judgment, quantitative amounts and qualitative aspects.
§ Overall materiality is a matter of professional judgment based initially
on a percentage applied to a chosen benchmark.
§ All material matters must be subject to substantive audit procedures.
§ There is an "inverse" relationship between audit risk and materiality.
The amount considered material must be decreased as the risk of
misstatement increases.
© ACCA 25
Thank you

© ACCA 26