Planning the Audit:

Materiality

Planning

Auditors approach
Determine
planning
materiality

Determine
tolerable
misstatement

Post FW

Fieldwork!

Evaluate
audit findings

Overall amount; relates to F/S as a whole

Relative to each client; % of F/S base as starting point

Base should make sense for the company/financial statements

Examples: Net Inc or Net Assets (3 5%), Rev or Total Assets (.5 2%)

Scaled-down materiality figure for an account balance

Needed for detailed planning and scoping decisions
Works as an early signal when a F/S line item has a problem
Based on the nature & ease of auditing the account
(Account TMs) may be larger than overall materiality

First, consider whether PM should be reassessed

Compare unadjusted misstatements to PMmaterial?
Consider the nature of misstatements, not just the
amountcould be material even if small $$

When judging whether misstatements are Consider known vs. likely misstatements
Consider qualitative attributes of misstatements
material:

Qualitative nature of a smalldollar misstatement

Could be material even if quantitatively small!

Practice Case: Materiality

See Example Firm Policy

on Materiality

Practice: Prob 3-31

focus on justifications

Problem 3-31
Scenario 1
Murphy & Johnson is a manufacturer of small motors for
lawnmowers, tractors, and snowmobiles. The components of its
financial statements are (1) net income before taxes = $21
million, (2) total assets = $550 million, and (3) total revenues =
$775 million.

Planning materiality?

Tolerable misstatement?

During the course of the audit, Murphy & Johnsons CPA firm
detected two misstatements that aggregated to an
overstatement of net income of $1.25 million.
b) Evaluate the audit findings. Justify your decisions.

a) Determine planning materiality, and determine

tolerable misstatement. Justify your decisions.
Planning Materiality-Base: NIBT (why?)
Benchmark: 3-5% of NIBT
Planning Materiality:
At 3% of NIBT, $630,000
At 5% of NIBT, $1.05 million

Tolerable Misstatement
Up to 50% of Planning Materiality

During the course of the audit, Murphy & Johnsons CPA firm
detected two misstatements that aggregated to an
overstatement of net income of $1.25 million.
b) Evaluate the audit findings. Justify your decisions.
Compare to planning materiality of either
$630,000 (At 3% NIBT) or
$1.05 million (At 5% NIBT)
The two detected misstatements exceed planning
materiality.
Auditor should propose an adjustment to the financial
statements so that the remaining misstatement would be
equal to or less than planning materiality.

Scenario 2
Delta Investments provides a group of mutual funds for
investors. The components of its financial statements are
(1) net income before taxes = $40 million, (2) total assets
= $4.3 billion, and (3) total revenues = $900 million.

Planning materiality?

Tolerable misstatement?

a) Determine planning materiality, and determine

tolerable misstatement. Justify your decisions.
Planning Materiality:
Base: Assets (why?)
Benchmark: 0.5% of Assets
Planning Materiality: $21.5 million ($4.3 b .005)

Tolerable Misstatement
Up to 50% of Planning Materiality

During the course of the audit, Deltas CPA firm

detected two misstatements that aggregated to an
overstatement of net income of $5.75 million.
b) Evaluate the audit findings. Justify your decisions.
Compare to planning materiality of $21.5
million.

Scenario 3
Swell Computers manufactures desktop and laptop
computers. The components of the financial assets are:
(1) net income = $500,000, (2) total assets = $2.2
billion, and (3) total revenues = $7 billion.

Planning materiality?
Tolerable misstatement?

a) Determine planning materiality and tolerable

misstatement. Justify your decisions.
Planning Materiality:
Base: Total Assets or Total Rev (why?)
Benchmark: 0.5%
Planning Materiality:
If Total Assets, then $2.2 b x .005 ($11 m)
If Total Revenues, then $7 b x .005 ($35 m)
Tolerable Misstatement:
Up to 50% of Planning Materiality

During the course of the audit, Swells CPA firm

detected one misstatement that resulted in an
overstatement of net income by $1.5 million.
b) Evaluate the audit findings. Justify your decisions.

Compare to planning materiality of either:

$11 m (Total Assets)
$35 m (Total Revenues)
So

21.Tolerable misstatement is
a)Always the same for errors and fraud.
b)Materiality for the balance sheet as a
whole.
c)Materiality for the income statement as a
whole.
d)Materiality allocated to a specific
account.

14.The existence of audit risk is recognized by the

statement in the auditors standard report that the
auditor
a)Obtains reasonable assurance about whether the
financial statements are free of material
misstatement.
b)Assesses the accounting principles used and also
evaluated the overall financial statement
presentation.
c) Realizes that some matters, either individually or in
the aggregate, are important while other matters are
not important.
d)Is responsible for expressing an opinion on the

17.Which of the following characteristics most likely

would heighten an auditors concern about the risk
of intentional manipulation of financial
statements?
a)Turnover of senior accounting personnel is low.
b)Insiders recently purchased additional shares of
the entitys stock.
c)Management places substantial emphasis on
meeting earnings projections.
d)The rate of change in the entitys industry is
slow.

22.As lower acceptable levels of both audit risk and

materiality are established, the auditor should plan
more work on individual accounts to

a)Find smaller errors.

b)Find larger errors.
c)Increase the tolerable misstatements in the
accounts.
d)Decrease the risk of overreliance.