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Materiality, Misstatements, and Reporting Part I
ISAs 320,Materiality in Planning and Performing an Audit
ISA Implementation Support ModuleNotes for Select Slides
The following supporting notes accompany the PowerPoint slides
for this module and do
not amend or override the ISAs, the texts of which alone are
authoritative. Reading these
notes is not a substitute for reading the ISAs. The notes are
not meant to be exhaustive and
reference to the ISAs themselves should always be made. In
conducting an audit in
accordance with ISAs, the auditor is required to comply with all
the ISAs that are relevant
to the engagement.
Slide 2 Notes
Overview of Module
o Outcome of revision of ISA 320 was two separate ISAs for
enhanced clarity:
A revised ISA 320 on determining and using materiality in
planning and
performing an audit.
A new ISA 450 on evaluating misstatements identified during the
audit.
o The concept of materiality links ISAs 320, 450 and 700. It is
applied in both
planning and performing the audit; in evaluating the effect of
identifiedmisstatements on the audit and of uncorrected
misstatements, if any, on the
financial statements; and in forming the opinion on the
financial statements.
Slide 5 Notes
Definition of materiality replaced by description of common
characteristics often
discussed in financial reporting frameworks (FRFs)
o Old standard defined materiality based on definition in IASB
literature
o Standard specifies 3 main characteristics of materiality
Misstatements are considered material if, individually or in the
aggregate, they
could reasonably be expected to influence the economic decisions
of users based on
the financial statements.
Judgments about materiality are made in context of surrounding
circumstances,
and are affected by the size and/or nature of a
misstatement.
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Module ISA 320-450-700 Part I
Notes for Select Slides
What is material to users depends on a consideration of their
common financial
information needs and not their individual needs.
Apply materiality in planning the audit
o Judgments about materiality during the planning phase provide
a basis for:
Determining the nature, timing and extent of risk assessment
procedures; and
Identifying and assessing the risks of material
misstatement.
o Important to bear in mind that materiality level(s) determined
when planning the
audit do not necessarily set an amount below which uncorrected
misstatements,
individually or in aggregate, will always be considered
immaterial. Circumstances
surrounding some misstatements may lead the auditor to evaluate
them as material
even if they are below materiality.
Slide 7 Notes
Standard provides guidance on choosing an appropriate
benchmark
o Factors that may be considered include:
Nature of the entity and its industry
The entitys ownership structure and how it is financed
Relative volatility of the benchmark
o Examples of benchmarks include:
Profit before tax on continuing operations
Total revenue
Total equity
Net asset value
o In the case of a small entity, profit before tax from
continuing operations may be
consistently nominal, e.g. if owner-manager withdraws much of
the profit before
tax in the form of remuneration. In such circumstances, it may
be more
appropriate to choose profit before remuneration and tax as a
benchmark.
No specific guidance on percentages provided
o IAASB intentionally avoided providing examples of percentages
that may be used
for specific types of benchmarks, for a number of reasons:
Rules of thumb could become de facto standards.
Examples may over-emphasize the quantitative aspects of
materiality relative to
the qualitative considerations.
Specific examples could inappropriately discourage auditors from
applying the
necessary professional judgment to determine the materiality
levels that are
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Module ISA 320-450-700 Part I
Notes for Select Slides
appropriate in the particular circumstances of the
engagement
Reviewers and inspectors may focus more on why the auditor did
not apply a
given percentage as opposed to how and why the auditor
determined a particular
percentage.
o There is a relationship between the percentage to be applied
and the benchmarkchosen, e.g. percentage applied to a
profit-before-tax benchmark will normally be
higher than one applied to a total-revenue benchmark.
o Consideration of the nature of the entity and the surrounding
circumstances is
necessary in determining an appropriate percentage.
Consider whether adjustments to benchmark needed for significant
changes in
entitys circumstances
o E.g., if the entity has made a significant business
acquisition giving rise to an
exceptional increase or decrease in profit, it may be
appropriate to use a
normalized profit figure based on past results.
o Note also that materiality relates to the financial statements
being reported on,
which may be for a period longer or shorter than 12 months.
Slide 8 Notes
Consider whether there are any relevant factors that may
indicate whether there
are particular items that would influence users judgments
o For example:
Users may be particularly sensitive to measurement or disclosure
of certain items
because of legal or regulatory requirements, e.g. disclosure of
related partytransactions and directors remuneration.
Users may focus on specific line items or disclosures in the
financial statements
that affect key ratios, e.g. loan loss provisions for a bank or
gearing.
o Understanding the views and expectations of management and
TCWG may help
in identifying whether there are particular items for which it
would be appropriate
to determine a specific materiality level(s).
Slide 9 Notes
Performance materiality (PM) less than materiality for financial
statements as a
whole
o An amount or amounts 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.
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Module ISA 320-450-700 Part I
Notes for Select Slides
o If applicable, it also refers to an amount or amounts set by
the auditor at less than
the materiality level(s) for particular classes of transactions,
account balances or
disclosures.
Serves two purposes
o It is, in a sense, a means by which the auditor can ensure
that the audit will bedesigned to obtain sufficient appropriate
audit evidence on which to base the
opinion on the financial statements.
Slide 10 Notes
Use of professional judgment is key
o Relevant factors that may be considered include:
Understanding of the entity
Nature and extent of prior period misstatements
Expectations of nature and extent of misstatements in current
period
o While performance materiality may be one or more amounts, it
is always less than
materiality for the financial statements as a whole.
Copyright October 2010 by the International Federation of
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make copies of
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2010 by the International Federation of Accountants (IFAC). All
rights reserved.Used with permission of IFAC.
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