Question

3) What’s the difference between “financial statement materiality” and “performance materiality” and how are they used in an audit. Provide an example.

Answer 1

Materiality

Materiality is a subject of professional judgment and discussion presented in Financial Reporting Framework provides

a reference to the auditor indetermining materiality.If Financial Reporting Framework does not include a discussion,

following can be referred:

(a) Misstatements including omissions expected to influence the economic decision of users.

(b) Size or nature of misstatement & the surrounding circumstances.

(c) Common financial information needs of the users as a group.

Financial statement

Items are material if they could influence the economic decisions of users.

Performance Materiality

 The amount set by auditor at

 less than materiality for Financial Statement as a whole

 to reduce to an appropriately low level

 the probability that the aggregate of the

uncorrected & undetected misstatement

 exceeds materiality for Financial Statement as a whole

Difference between Financial Statement Materiality and Performance Materiality

1. F.S. Materiality refers to the state where        Performance materiality is the amount

financial information has the ability to             of variation that can exist in individual financial

affect economic decisions of users or             accounts due to errors and omissions without

the discharge of accountability by                   affecting the auditor’s opinion regarding the

management or those charged with                objectivity of financial statements.

governance if some information is

misstated, omitted or not disclosed.

2.Level of F.S. Materiality is based on the needs and       Level of performance materiality is based

expectations of the users of financial information. on the assessment of audit risk.

3.F.S. Materiality is a standalone concept. Performance materiality depends on the    

level of materiality.

Materiality used in an audit

A %age is often applied to a chosen benchmark as a starting point in determining materiality

for the Financial Statement as a whole.

(a) Upon establishing the overall audit strategy, the auditor shall determine the materiality

      for the Financial Statement as a whole.

(b) Determine the materiality level for specific transactions for which misstatements of lower

      amount be expected to influence the economic decisions of users.

(c) Determine performance materiality for purpose of assessing the Risk of Material Misstatement

and determining the Nature Time & Extent of further audit procedures.

Judgment of materiality provides a basis for:

(a) Determination of Nature Time & Extent of Risk Assessment Procedures

(b) Identifying and assessing Risk of Material Misstatement .

(c) Nature Time & Extent of further audit procedures.

Example:-

1% Overall materiality of sales which is $500,000 materiality.
Now I will take, lets say, 75% of 500000 to calculate tolerable error, which will be used on account balance working papers.