Chapter 4: Section 4

Question 1

What is materiality?

Answer 1

If either the omission or misstatement of an item could reasonably affect the economic decisions of users of a set of financial statements, then that item is considered material to those financial statements

Question 2

What ISA helps define the term materiality?

Answer 2

ISA 320 Materiality in Planning and Performing an Audit

Question 3

What does ISA 320 say in para 10 about materiality?

Answer 3

‘When establishing overall audit strategy, the auditor shall determine materiality for the financial statements as a whole.
If, in specific circumstances of the entity, there is one or more particular classes of transactions, account balances or disclosures for which misstatements of lesser amounts than materiality for the financial statements as a whole could reasonable be expected to influence the economic decisions of users taken on the basis of financial statements, the auditor shall also determine the materiality level or levels to be applied to those particular classes of transactions, account balances or disclosures.’

Question 4

With the definition provided by ISA 320, in what way can items be material?

Answer 4

Material by nature: related parties and related party transactions

Question 5

What risk are items material by nature: related parties and related party transactions considered to be?

Answer 5

Significant risk

Question 6

Why are items which can be material by nature: related parties and related party transactions considered to be significant?

Answer 6

Affect profits earned but may not obvious to the audit team - hence they should always be prioritised and reported to senior audit team members to ensure correct treatment in the financial statements.

Question 7

Why is materiality important?

Answer 7

Determines the threshold above which further audit work becomes necessary, as well as confirming those misstatements or omissions that will have to be considered as part of the audit opinion

Question 8

What must the auditor calculate regarding materiality?

Answer 8

A suitable level of materiality for the financial statements as a whole

Question 9

When calculating materiality for the financial statements as a whole what will the materiality often be?

Answer 9

A percentage of a significant benchmark in the financial statements

Question 10

What will calculating materiality always be a matter of?

Answer 10

Professional judgement so percentages will not simply be applied without thought

Question 11

What is a useful guide to materiality levels to consider something is material if it is what 3 things?

Answer 11

1. 5-10% of profit before tax
2. 1-2% of revenue
3. 2-5% of total assets

Question 12

Rather than calculate materiality for financial statements as a whole, what may the auditor need to do?

Answer 12

Calculate material levels for specific items in the financial statements which are particularly significant to users for any reason

Question 13

Why do auditors need to calculate material levels for specific items in the financial statements?

Answer 13

Some items might be material simply because of what they are

Question 14

What thing in the financial statements is usually considered to be material and why?

Answer 14

Due to legal restrictions around directors’ remuneration disclosures in the UK, any matter relating to directors in financial statements is usually considered to be material

Question 15

What else could cause a misstatement to be considered material and given an example?

Answer 15

Its effect e.g., if a small misstatement made the company breach a covenant made with its bank, it might be considered material

Question 16

What is performance materiality?

Answer 16

Amount or amounts set by the auditor at less than materiality for the financial statements as a whole.
This reduces to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole

Question 17

What does ISA 320: para 1 say is the purpose of performance materiality?

Answer 17

The auditor shall determine performance materiality for purposes of assessing the risks of material misstatement and determining the nature, timing and extent of further audit procedures.

Question 18

What is the downside with setting one level of materiality?

Answer 18

Means there could be items below this level which are misstated but not classed as material and hence not tested - if there were several of these, there is a risk that the sum of these could constitute a material misstatement that the auditor never knew about

Question 19

What is done to address the downside of setting one level of materiality?

Answer 19

A second level of materiality is set by the auditor and used to select specific amounts where the risk of aggregate immaterial misstatements is highest

Question 20

Who decides what around the second level of materiality?

Answer 20

Again a matter of professional judgement for the auditor on both the amount and classes of transaction or account balance selected

Question 21

What is the second level of materiality called?

Answer 21

Performance materiality

Question 22

When can we explore the idea of performance material further - when considering what ISA?

Answer 22

ISA 450 Evaluation of Misstatements Identified During the Audit

Question 23

What ISA speaks about revision of materiality as the audit progresses?

Answer 23

ISA 320: para. 12

Question 24

What does ISA 320: para. 12 say about revision of materiality as the audit progresses?

Answer 24

‘The auditor shall revise materiality for the financial statements as a whole (and, if applicable, the materiality level or levels or particular classes of transactions, account balances or disclosures) in the event of becoming aware of information during the audit that would have caused the auditor to have determined a different amount (or amounts) initially.’

Question 25

What ISA and para talks about the documentation of materiality?

Answer 25

ISA 320: para. 14

Question 26

What does ISA 320: para. 14 say about documentation of materiality?

Answer 26

'The auditor shall include in the audit documentation the following amounts and the factors considered in their determination: (a) Materiality for the financial statements as a whole (b) If applicable, the materiality level or levels for particular classes of transactions, account balances or disclosures (c) Performance materiality (d) Any revision of (a)-(c) as the audit progressed.'

Question 27

Why is point (d) in documenting of materiality factors by ISA 320: para. 14 important?

Answer 27

Logical that, in order to document the process of reaching the audit opinion, as well as the assumptions made, any changes in those assumptions should also be documented

Question 28

What may you be asked to do when evaluating materiality of a misstatement or similar issue?

Answer 28

May be asked to differentiate between the terms 'material' and 'material and pervasive'

Question 29

What ISA provides the definitions of the term 'material and pervasive'?

Answer 29

ISA 705 (revised) Modifications to the Opinion in the Independent Auditor's Report

Question 30

What does ISA 705 (revised) say is the definition of 'material and pervasive'?

Answer 30

-Are not confined to specific elements, accounts or items of the financial statements -If so confined, represent or could represent a substantial proportion of the financial statements -In relation to disclosures, are fundamental to users' understanding of the financial statements (ISA 705: para. 5(a))