Auditing Materiality Concepts Quiz

Performance Materiality

• The amount set by the auditor at less than materiality for the financial statements as a whole to reduce the chance of undetected misstatements exceeding the overall materiality threshold.
• It represents a lower threshold specifically designed to provide a reasonable level of assurance.
• It's also the amount set by an auditor for specific categories of transactions, account balances, or disclosures.

Materiality: Qualitative Factors

• Some misstatements may fall under specified benchmarks but are still considered material due to their qualitative effects.
• Qualitative factors can make even small misstatements significant if they affect users' understanding of a company’s financial performance or position.
• Examples of qualitative factors include:
  • Laws, regulations, or accounting standards impacting user perception of certain items.
  • Critical disclosures relevant to a company's industry.
  • Aspects of a company’s business that are separately disclosed in the financial statements.

Material Account (SEC Definition)

• A balance sheet or income statement item whose amount is equivalent to:
  • 1% of total assets.
  • 1% of total revenue.
  • 5% of net income before taxes.

Documentation of Materiality

• The audit documentation should include:
  • Materiality for the financial statements as a whole.
  • Materiality level for specific classes of transactions, account balances, or disclosures (if applicable).
  • Performance materiality.
  • Any adjustments to the above throughout the audit process.

Understanding the Entity and Its Environment

• The objective of the auditor is to identify and assess risks of material misstatement, whether due to fraud or error, at both the financial statement and assertion levels.
• This understanding helps auditors design and implement appropriate audit procedures.
• It also informs the exercise of professional judgment, such as setting audit materiality levels.

How to Gain an Understanding

• The auditor will use various resources to gain understanding of the entity and its environment:
  • Permanent audit file: Contains enduring information relevant to the audit.
  • Previous year's audit working papers.
  • Information from the client’s website.
  • Publications or websites about the client's industry.

Procedures for Understanding

• Procedures used to gain an understanding include:
  • Inquiries of management, internal auditors, and other personnel within the entity.
  • Analytical procedures.
  • Observation and inspection.

Audit Risks and Responses

• Specific risks and responses vary depending on the client and their environment.
• The focus should be on understanding the link between risks and responses, rather than memorizing a list of responses.
• Examples of common risks and potential responses:
  • New client systems or staff: Conduct interim audits, evaluate new systems, increase sample sizes for testing.
  • Management incentive to manipulate performance: Increase testing of judgmental areas in the financial statements.

Audit Procedures When Non-compliance is Suspected

• Factors that may signify non-compliance with laws and regulations include:
  • Investigations by regulatory authorities.
  • Payment of fines or penalties.
  • Unusual payments in cash.
  • Transactions with companies registered in tax havens.
  • Payments without proper exchange control documentation.
  • Existence of inadequate information systems or insufficient evidence.
  • Unauthorized or improperly recorded transactions.
  • Adverse media comment.

Audit Procedures in Response to Non-Compliance

• Procedures include:
  • Understanding the nature of the potential non-compliance and the circumstances surrounding it.
  • Gathering additional information to evaluate the potential effect on the financial statements.
  • Discussing the matter with management and those charged with governance.
  • Considering the need to obtain legal advice, if necessary.
  • Evaluating the impact on the auditor’s opinion if sufficient information is not obtained.
  • Assessing implications on risk assessment and the reliability of written representations.

Reporting Non-Compliance

• Communicate findings to those charged with governance, but if they are implicated, report to a higher level, such as the audit committee or supervisory board.
• If no such higher body exists, consider obtaining legal advice.

Test your understanding of performance materiality and qualitative factors in auditing. This quiz covers the definitions and implications of these key concepts, providing examples to enhance your knowledge of financial statement assurance. Perfect for students and professionals in accounting and auditing.