Reference no: EM133238732

In the engagement planning process, one of the most critical decisions to be made is the materiality threshold. This threshold is set by the auditors in determining whether a misstatement in the financial statements can affect users' decisions. This also assists auditors in knowing if a misstatement is worth digging into further. Once the materiality threshold is made; this does not mean that it is set in stone. If information arises during the audit that refutes the threshold amount, then a recalculation is required.

AU Section 320, Materiality in Planning and Performing an Audit, provides guidance on setting the threshold however, there are no set standards on how to calculate it. When auditors use their professional judgment, in calculating materiality, both quantitative and qualitative factors are considered.

Quantitative factors, the relative magnitude of the items in question, has three commonly used benchmarks: .5% to 1% of revenues, 1% to 2% of total assets, and/or 5% to 10% of net profits.

Qualitative factors, or the surrounding circumstances, could be if the company is private or publicly traded, organizational or operation characteristics, or the type of industry. '

Auditors have a lot to consider for materiality. Not only do they need to think about the overall financial statement materiality, but they also need to consider performance materiality. If misstatements are made, and not corrected or notated, what is going to be considered material?

Testing and verifying account balances and transactions are ways to assert that financial statements are providing true and accurate information. Once the materiality threshold is made, the auditor can determine which account balances to review. Typically account balances refer to balance sheet accounts whereas transactional assertions refer to revenue and expenses.

When going through an audit, some items could be below the material threshold but are still considered material. Any items that would have an impact on the overall financial statement, such as putting the company in a net profit versus a net loss, or vis versa, in these situations they are always considered material.

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