Materiality Considerations in an Audit - Web.ppt

Materiality Considerations in an Audit Dr. Donald K. McConnell Jr. Materiality: a Difficult Concept for Inexperienced Auditors to Grasp It’s not your fault! We educate you with the wrong mindset! Materiality should be viewed in relation to audit client’s size; not your personal finances Why Must We Develop Materiality Criteria in an Audit? Adequate planning requires preliminary judgments about materiality levels for audit purposes (Au 311.03) The audit report says the financial statements present fairly in all material respects Once established, materiality defines: Levels for audit AJE’s Scopes for audit testing FASB Tried to Define Materiality Issued an extensive Discussion Memorandum (DM) years ago Charge: to develop materiality criteria the profession could use Conclusion: no consensus could be reached! Materiality is a matter of auditor’s judgment FASB Concepts Statement No. 2 Defines Materiality Qualitatively “… the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.” Materiality Has Two Dimensions Qualitative aspects Quantitative aspects CPA Firms Tend to Want to Use Quantitative Measurements Inexperienced audit seniors can readily plug numbers from financial statements into a formula Intrafirm consistency in defining materiality is desirable! One Major CPA Firm’s Pre-Au 312 Response to Lack of Authoritative Guidance Quantitative materiality defined (a black box approach): The greater of total assets or revenues Times 1.6 Quantity raised to the two-thirds power! M=[Greater of TA or Rev x 1.6]^2/3 Au 312.19 later said should be “lower of” How Do We Develop Quantitative Materiality in the Planning Phases? The problem: materiality must be defined three to four months before year end The underlying theory of analytical procedures is relevant