Question

Overall Materiality Calculation- Example 1

Use the guidelines for Willis and Adams for the materiality bases and their respective ranges.  You have been tasked with determining the overall materiality assessment for your audit client, TechToys for the year-ended 2018.  You have begun your planning procedures in July of 2018. The client has provided you with the actual pretax income for the first quarter 2018 ($4 million) and the second quarter 2018 ($10 million).  TechToys expects pretax income to remain stable for the third quarter.  It also expects an increase of 30% from the third to fourth quarter for the holiday season.  This growth is consistent with the prior year pretax income, which has been steadily increase 2-3% each year.   Assets at June 30, 2018 are $10 billion and revenues are forecasted to be $200 million for the year.  Assets and revenues also remain stable year over year.

In addition, the below lists provides some information regarding you client, ABC Company:

The entity is publicly traded and is regulated entity.

A material audit differences was identified in the prior year.

The technology space for tech gadgets, such as the fitness watch, has begun to decline in the past year.

Answer 1

• Audit materiality is one of the most important concepts for auditors. Misstatements, including omissions, are considered to be material if, individually or in the aggregate, they are reasonably expected to influence the economic decisions of users based on the financial statements.
• As the basis for the auditor's opinion, ISAs requireauditors to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement. The concept of materiality is therefore fundamental to the audit.
• The materiality principle states that an accounting standard can be ignored if the net impact of doing so has such a small impact on the financial statements that a reader of the financial statements would not be misled.
• Following are the methods which offer a suggested range for the calculation of materiality:

1. 5% of pre-tax income;
2. 0.5% of total assets;
3. 0.5% of total revenue.

• Calculation of materiality on the basis of above information:

5% of pre-tax profit (W.N. 1) (5% * 37,000,000)	$1,850,000
0.5% of total assets (0.5% * 10,000,000,000)	$50,000,000
0.5% of total revenue (0.5% * 200,000,000)	$1,000,000

Conclusion:

Lowest of the above shall be the level of materiality i.e. $1,000,000 for the year under audit.

W.N. 1 - Calculation of Pre-tax profits:

Quarter 1	4,000,000
Quarter 2	10,000,000
Quarter 3	10,000,000
Quarter 4 (10,000,000 + 30% of 10,000,000)	13,000,000
Total Pre-tax profit for the year	37,000,000