MODULE 2 – MATERALITY, SAMPLING, AND DATA ANALYTIC METHODS
The U.S. Supreme Court defines materiality slightly different: “a fact is material if there is a
substantial likelihood that the … fact would have been viewed by the reasonable investor as
having significantly altered the ‘total mix’ of information made available….” FASB Concepts
Statements No. 2 defines materiality as “the magnitude of an omission or misstatement of
accounting information that, in 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.”
Answer 1: Performance materiality, also called tolerable misstatement, is generally a % of Total
(Planning) materiality (such as 75% of total/planning materiality) and is used for account-level
testing, rather than assessment of the overall financial statements.
Answer 2: Planning materiality, also called Overall materiality or total materiality or materiality
level, is used for assessment of the overall financial statement correctness.
Answer 3: Specific materiality can be assigned to a particular, or specific, account-area if the
auditor determines that such a designation is needed. For example, if the auditor determines
that a particular account needs a lower materiality threshold than all other accounts because of
errors are expected to be found in that account due to a complex transaction.
Answer 4: Posting materiality, also called trivial materiality, is a materiality level that signifies the
misstatements identified through the audit that will be considered at the end of the audit in
determining whether the financial statements overall are materially correct. Generally this is a %
of Planning materiality (such as 5% of planning materiality). Any errors identified by the auditor
,as equal to or below Posting materiality are deemed not to be errors at all due to their small
size.
Any errors identified by the auditor as equal to or below Posting materiality are deemed not to
be errors at all due to their small size.
Any misstatements above Overall/planning materiality are automatically deemed to be material
misstatements. If the client does not make adjusting entries to correct these, the audit will issue
either a modified/qualified opinion or an adverse opinion, depending on how pervasive the
uncorrected misstatements are to the financial statements.
Auditors will accumulate all misstatements that are above posting materiality, and below
overall/planning materiality, during the audit. Then at the end of the audit, the auditor will
aggregate these items to determine if the aggregated effect of the immaterial misstatements has
become material.
The auditor will reassess what they previously did based on the old materiality amounts and
consider any changes that should be made. It doesn’t automatically mean that they need to re-
perform all audit procedures, but that is a possibility depending on the reason and amount of the
changes.
,When controls are poorly designed and/or not working properly, the result is an increased risk
that control will not prevent nor detect a material misstatement of noncompliance with a law or
regulation in a timely fashion.
Trend analysis is an analytical technique that includes simple year-to-year comparisons of
account balances, graphic presentations, analysis of financial data, histograms of ratios, and
projections of account balances based on the history of changes in the account.
Audit Risk = Inherent risk x Control risk x Detection risk
, Risk of material misstatement = Inherent risk x Control risk. If key personnel depart, that could
reduce the effectiveness of internal controls, thus increasing control risk and therefore
increasing Risk of material misstatement.
Audit risk is, generally speaking, the risk that the auditor will give an unqualified opinion when
they should have modified the opinion (which is pretty much the worse thing an auditor can do).
The higher the risk of material misstatement is, the lower the acceptable audit risk needs to be.
Audit risk is usually either 5% (i.e., 95% confident that the audit opinion is correct) of 1% (i.e.,
99% confident that the audit opinion is correct). If risk of material misstatement is high, then
audit risk would need to be set to low 1%. If risk of material misstatement is low, then the auditor
wouldn’t need to be as confident and audit risk could be set to 5%.
The U.S. Supreme Court defines materiality slightly different: “a fact is material if there is a
substantial likelihood that the … fact would have been viewed by the reasonable investor as
having significantly altered the ‘total mix’ of information made available….” FASB Concepts
Statements No. 2 defines materiality as “the magnitude of an omission or misstatement of
accounting information that, in 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.”
Answer 1: Performance materiality, also called tolerable misstatement, is generally a % of Total
(Planning) materiality (such as 75% of total/planning materiality) and is used for account-level
testing, rather than assessment of the overall financial statements.
Answer 2: Planning materiality, also called Overall materiality or total materiality or materiality
level, is used for assessment of the overall financial statement correctness.
Answer 3: Specific materiality can be assigned to a particular, or specific, account-area if the
auditor determines that such a designation is needed. For example, if the auditor determines
that a particular account needs a lower materiality threshold than all other accounts because of
errors are expected to be found in that account due to a complex transaction.
Answer 4: Posting materiality, also called trivial materiality, is a materiality level that signifies the
misstatements identified through the audit that will be considered at the end of the audit in
determining whether the financial statements overall are materially correct. Generally this is a %
of Planning materiality (such as 5% of planning materiality). Any errors identified by the auditor
,as equal to or below Posting materiality are deemed not to be errors at all due to their small
size.
Any errors identified by the auditor as equal to or below Posting materiality are deemed not to
be errors at all due to their small size.
Any misstatements above Overall/planning materiality are automatically deemed to be material
misstatements. If the client does not make adjusting entries to correct these, the audit will issue
either a modified/qualified opinion or an adverse opinion, depending on how pervasive the
uncorrected misstatements are to the financial statements.
Auditors will accumulate all misstatements that are above posting materiality, and below
overall/planning materiality, during the audit. Then at the end of the audit, the auditor will
aggregate these items to determine if the aggregated effect of the immaterial misstatements has
become material.
The auditor will reassess what they previously did based on the old materiality amounts and
consider any changes that should be made. It doesn’t automatically mean that they need to re-
perform all audit procedures, but that is a possibility depending on the reason and amount of the
changes.
,When controls are poorly designed and/or not working properly, the result is an increased risk
that control will not prevent nor detect a material misstatement of noncompliance with a law or
regulation in a timely fashion.
Trend analysis is an analytical technique that includes simple year-to-year comparisons of
account balances, graphic presentations, analysis of financial data, histograms of ratios, and
projections of account balances based on the history of changes in the account.
Audit Risk = Inherent risk x Control risk x Detection risk
, Risk of material misstatement = Inherent risk x Control risk. If key personnel depart, that could
reduce the effectiveness of internal controls, thus increasing control risk and therefore
increasing Risk of material misstatement.
Audit risk is, generally speaking, the risk that the auditor will give an unqualified opinion when
they should have modified the opinion (which is pretty much the worse thing an auditor can do).
The higher the risk of material misstatement is, the lower the acceptable audit risk needs to be.
Audit risk is usually either 5% (i.e., 95% confident that the audit opinion is correct) of 1% (i.e.,
99% confident that the audit opinion is correct). If risk of material misstatement is high, then
audit risk would need to be set to low 1%. If risk of material misstatement is low, then the auditor
wouldn’t need to be as confident and audit risk could be set to 5%.
