ISA Implementation Support Module

Prepared by IAASB Staff

October 2010

Materiality, Misstatements and Reporting − Part I

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(Old) ISA 320

(Revised) ISA 320

(New) ISA 450

(Amended) ISA 700

(Old) ISA 700

Overview of Module

• Introduction

• Significant Features of New Standard

– New Approach to Understanding Materiality

– Materiality Levels

• Materiality for Financial Statements as a WholeMateriality for Financial Statements as a Whole

• Materiality for Particular Classes of Transactions, Account Materiality for Particular Classes of Transactions, Account Balances or DisclosuresBalances or Disclosures

• Performance MaterialityPerformance Materiality

– Revision of Materiality

– Documentation

Overview of ISA 320

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• The context for revising ISA 320

– Developments in national standards and guidance

– Need for greater consideration of nature of an item and the entity’s circumstances when determining materiality and evaluating misstatements

– Importance of considering possibility of aggressive earnings management and management bias when evaluating whether the financial statements are free of material misstatement

Introduction

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• Definition of materiality replaced by description of common characteristics often discussed in financial reporting frameworks (FRFs)

– If FRF provides a definition or discussion of materiality, use this as a frame of reference in determining materiality for the audit

– If not, use characteristics in the ISA as a frame of reference

• Apply materiality in

– Planning the audit

– Determining nature, timing and extent of further procedures

New Approach to Understanding Materiality

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Materiality Levels

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Materiality for the financial statements as a whole

Particular classes of transactions, account

balances or disclosures, if any

Performance materiality(s) for

above, if any

Performance materiality for assessing risks and planning

further audit procedures

• Users’ information needs drive overall materiality level

– No specific methodologies prescribed − use of professional judgment is key

• Often a percentage of a chosen benchmark may be an appropriate starting point

– Standard provides guidance on choosing an appropriate benchmark

– No specific guidance on percentages provided

• Consider whether adjustments to benchmark needed for significant changes in entity’s circumstances

Materiality for Financial Statements as a Whole

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• Lower materiality levels used if specific items would influence users’ economic decisions taken on the basis of the financial statements

– However, this does not mean a materiality level needs to be determined for every line item or disclosure

• Consider whether there are any relevant factors that may indicate whether there are particular items that would influence users’ judgments

Materiality for Particular Classes of Transactions, Account Balances, or Disclosures

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• Performance materiality (PM) less than materiality for financial statements as a whole

• Serves two purposes:

– To allow for aggregation of immaterial amounts

– To provide margin for possible undetected misstatements

• Used to:

– Assess risks of material misstatement

– Determine nature, timing and extent of further audit procedures

Performance Materiality

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• Possible approaches:

– One PM level based on materiality for financial statements as a whole, or

– More than one PM level in relation to different items

• If materiality level(s) have been set for particular items, PM also refers to amount(s) set at less than these levels

• Determination of PM not a mechanical exercise

– Use of professional judgment is key

Performance Materiality

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• Materiality levels not cast in stone once determined

• Adjust as necessary as the audit progresses for

– Changes in entity’s circumstances

– New information

– Change in understanding of entity and its operations

• If materiality levels adjusted, consider whether nature, timing, and extent of further audit procedures also need adjustment

Revision of Materiality

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• Document

– Materiality for financial statements as a whole

– Materiality level(s) for particular items

– Performance materiality for above

– Revisions to the above as the audit progresses

Documentation

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Note

This set of support slides does not amend or override the ISAs, the texts of which alone are authoritative. Reading the slides is not a substitute for reading the ISAs. The slides are not meant to be exhaustive and reference to the ISAs themselves should always be made. In conducting an audit in accordance with ISAs, the auditor is required to comply with all the ISAs that are relevant to the engagement.

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