LS 2.90 - PSA 320 Materiality in The Planning and Performing An Audit

LS 2.
90
PSA 320. MATERIALITY IN THE PLANNING AND PERFORMING AN AUDIT
Auditing and Assurance Services
 Use of Materiality in the Audit
Risk Assessment Risk Response Reporting

Determining:  Determining the nature,  Evaluating the effect of
 Materiality for the timing, and extent of further uncorrected misstatements
financial statements as a audit procedures  Forming the opinion in the
whole  Revisions to materiality as a auditor’s report
 Performance materiality result of a change in
 Planning what risk circumstances during the
assessment procedures to audit
perform
 Identifying and assessing
the risks of material
misstatement
 Without identifying and assessing risk of material misstatements of financial statements, the
auditor will not have an appropriate basis to perform an effective audit
 PSA 320 (Materiality in the Planning and Performing an Audit) should be read in the context
of PSA 200 (Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Philippine Standards on Auditing)
 PSA 320 Important Paragraphs
SCOPE OF THIS PSA

1. This Philippine Standard on Auditing (PSA) deals with the auditor’s responsibility to apply the
concept of materiality in planning and performing an audit of financial statements. PSA 450
(Revised and Redrafted) explains how materiality is applied in evaluating the effect of
identified misstatements on the audit and of uncorrected misstatements, if any, on the
financial statements.
MATERIALITY IN THE CONTEXT OF AN AUDIT
2. Financial reporting frameworks often discuss the concept of materiality in the context of the
preparation and presentation of financial statements. Although financial reporting
frameworks may discuss materiality in different terms, they generally explain that:
• Misstatements, including omissions, are considered to be material if they, individually
or in the aggregate, could reasonably be expected to influence the economic decisions
of users taken on the basis of the financial statements;
• Judgments about materiality are made in light of surrounding circumstances, and are
affected by the size or nature of a misstatement, or a combination of both; and
• Judgments about matters that are material to users of the financial statements are
based on a consideration of the common financial information needs of users as a
group. 2 The possible effect of misstatements on specific individual users, whose needs
may vary widely, is not considered.
4. The auditor’s determination of materiality is a matter of professional judgment, and is affected

by the auditor’s perception of the financial information needs of users of the financial
statements. In this context, it is reasonable for the auditor to assume that users:
(a) Have a reasonable knowledge of business and economic activities and accounting and
a willingness to study the information in the financial statements with reasonable
diligence;
(b) Understand that financial statements are prepared, presented and audited to levels of
materiality;
(c) Recognize the uncertainties inherent in the measurement of amounts based on the use
of estimates, judgment and the consideration of future events; and
(d) Make reasonable economic decisions on the basis of the information in the financial
statements.
5. The concept of materiality is applied by the auditor both in planning and performing the audit,
and in evaluating the effect of identified misstatements on the audit and of uncorrected
misstatements, if any, on the financial statements and in forming the opinion in the auditor’s
report. (Ref: Para. A1)
6. In planning the audit, the auditor makes judgments about the size of misstatements that will
be considered material. These judgments provide a basis for:
(a) Determining the nature, timing and extent of risk assessment procedures;
(b) Identifying and assessing the risks of material misstatement; and
(c) Determining the nature, timing and extent of further audit procedures.
The materiality determined when planning the audit does not necessarily establish an amount
below which uncorrected misstatements, individually or in the aggregate, will always be
evaluated as immaterial. The circumstances related to some misstatements may cause the
auditor to evaluate them as material even if they are below materiality. Although it is not
practicable to design audit procedures to detect misstatements that could be material solely
because of their nature, the auditor considers not only the size but also the nature of
uncorrected misstatements, and the particular circumstances of their occurrence, when
evaluating their effect on the financial statements.
OBJECTIVE
8. The objective of the auditor is to apply the concept of materiality appropriately in planning
and performing the audit.
DEFINITION
9. For purposes of the PSAs, performance materiality means the amount or amounts set by the
auditor at less than materiality for the financial statements as a whole to reduce to an
appropriately low level the probability that the aggregate of uncorrected and undetected
misstatements exceeds materiality for the financial statements as a whole. If applicable,
performance materiality also refers to the amount or amounts set by the auditor at less than
the materiality level or levels for particular classes of transactions, account balances or
disclosures.
DOCUMENTATION
14. The audit documentation shall include the following amounts and the factors considered in
their determination:
(a) Materiality for the financial statements as a whole (see paragraph 10);
(b) If applicable, the materiality level or levels for particular classes of transactions,
account balances or disclosures (see paragraph 10);
(c) Performance materiality (see paragraph 11); and
(d) Any revision of (a)-(c) as the audit progressed (see paragraphs 12-13).
 Use of Materiality in the Audit (cont.)

 Levels of Materiality (Rules of Thumb…)
Overall Specific Performance

(materiality as a whole) (identifiable to a specific (used by auditor to reduce
transaction, account, the risk to an appropriate
disclosures…) low level: particular classes
of transactions, account or
disclosures)
Materiality as a matter of Establish a lower specific No specific guidance
professional judgement materiality amount (based provided by PSAs. Range
rather than mechanical on professional judgment) from 60% (overall or
existence. In practice profit for the audit of specific or specific materiality) where
from continuing operations = sensitive F/S areas there is a higher RMM, up
3% - 7% to 85% where the assessed
RMM is less
- Revenues and
expenditures: 1 – 3%
- Assets: 1 – 3%
- Equity: 3 – 5%
Professional Judgment – maximum misstatement (size and nature) in the financial statements
that could influence user’s economic decisions
 Information is material if its misstatement, including omission, could influence the economic
decisions of users taken on the basis of the financial statements
 Typical Misstatements
 Errors and fraud identified in the
preparation of the financial statements
 Departures from the applicable financial
reporting framework
 Fraud perpetrated by employees or
management
 Management error
 Preparation of inaccurate or inappropriate
estimates; or
 Inappropriate, unclear or incomplete
descriptions of accounting policies or note
disclosures in the financial statements
Materiality and Audit Risk (ref. PSA 320. A1)

 Information is material if its omission or misstatement could influence the economic decision
of users taken on the basis of the financial statements
 Materiality vs. Audit Risk: while audit risk refers to inappropriate audit opinion issued on F/S,
materiality is the total amount of misstatements in F/S which, if exceeded, could influence
user’s economic decisions.
 Materiality and audit risk is inversely related
 Materiality has an inverse relationship with audit procedures and audit evidence
o The lower the materiality, the more extensive procedures are performed and the
more evidence is gathered
o A lower materiality, even a smaller misstatement could be material that therefore
requires more extensive audit in order to detect such misstatement
Materiality
May be viewed as:
 Largest amount of misstatement that the auditor could tolerate in the financial statements
 Smallest aggregate amount that could misstate the financial statements
 Quantitative Considerations
a. Materiality for financial statements as a whole (General Materiality)
b. Materiality for particular classes of transactions, account balances, or disclosures, if
necessary (Particular Materiality)
c. Performance materiality
 Qualitative Considerations – possibility of material misstatements, such as:

 Accounting estimates (allowance for bad debts, retirement obligations, etc)
 Suspicious accounts (related party transactions, miscellaneous accounts)
Using Materiality in an Audit
Step 1. Determine the overall materiality – Financial Statement Level

- Materiality is considered as the smallest aggregate level of misstatement that
could distort any one of the financial statements
Step 2. Determine the tolerable misstatement – Account Balance Level

- Determine the audit procedures that will be applied to a specific accounts
- The allocated materiality to an account is called the tolerable misstatement for
the account
Step 3. Compare the aggregate amount of uncorrected misstatements with the overall
materiality
Basis:
- Annualized interim financial statements
- Prior year’s financial statements
- Budgeted financial statements of the current year
Based on the audit risk, the auditor will select a value inside this range (rule of thumb)…
0.5% to 2% of gross revenue
0.5% to 2% of total assets
1% to 2% of gross profit
1% to 5% of shareholders’ equity
5% to 10% current assets
5% to 10% current liabilities
5% to 10% of net profit (pre-tax profit from continuing operations)

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LS 2.

 Use of Materiality in the Audit

Risk Assessment Risk Response Reporting

 PSA 320 Important Paragraphs

SCOPE OF THIS PSA

MATERIALITY IN THE CONTEXT OF AN AUDIT

4. The auditor’s determination of materiality is a matter of professional judgment, and is affected

(b) Identifying and assessing the risks of material misstatement; and

 Use of Materiality in the Audit (cont.)

Overall Specific Performance

Materiality and Audit Risk (ref. PSA 320. A1)

 Qualitative Considerations – possibility of material misstatements, such as:

Using Materiality in an Audit

Step 1. Determine the overall materiality – Financial Statement Level

Step 2. Determine the tolerable misstatement – Account Balance Level

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