Ch. 5 - Materiality

Question 1

Steps to Determine Materiality (8)

Answer 1

1. Identify users of FS
2. Identify users’ objectives
3. Determine the base
4. Identify the percentage threshold
5. Determine overall materiality
6. Determine performance materiality
7. Determine specific materiality
8. Determine specific performance materiality

Question 2

Identify the Users of the FS (examples)

Answer 2

1. lenders
2. shareholders
3. potential investors
4. management (for compensation)

Question 3

Identify Users’ Objectives (examples)

Answer 3

1. Banks - will they be able to make payments (profitability)
2. shareholders - how is the return on my investment (profitability)
3. lenders - do we have collateral (assets)
4. management - how big will my bonus be (profitability)

Question 4

Determine the Base (options)

Answer 4

1. normalized income before tax
2. total assets
3. total revenues
4. total expenses
5. total equity

Question 5

Identify the Percentage Threshold for Materiality

• ranges
• purpose of range

Answer 5

1. normalized income (3-7%)
2. revenues/expenses (1-3%)
3. total assets (1-3%)
4. equity (3-5%)
   The range is meant to represent the sensitivity to errors (more sensitive means lower end of range; less sensitive means higher end of range)

Question 6

Determine Overall materiality

- one step before calculation

Answer 6

check for non-recurring items that should be removed before calculation

Question 7

Determine Performance Materiality

• why
• suggested calculation
• what impacts PM

Answer 7

• to ensure that misstatements (identified and unidentified) will not exceed materiality
• 60-80% of overall materiality
• risk impacts PM, but not overall materiality

Question 8

Determine Specific Materiality

- why used

Answer 8

• when certain accounts would have more of an impact on decision making than others
• based on whether the users have certain sensitivities

Question 9

Determine Specific Performance Materiality

- how

Answer 9

• is based on the RMM - the higher the risk, lower the SPM; the lower the risk, the higher the SPM

Question 10

relationship b/w materiality and RMM

Answer 10

There is no relationship b/w materiality and RMM.