I believe the auditor would suggest an adjusting entry to correct the inventory balance. Therefore the overall financial statement materiality threshold won't matter unless management refuses to make the adjustment. If that happened then the auditor may need to lower performance materiality and look for smaller mistatements in other financial statement elements in order to ascertain if the overall financial statements are materially misstated or not.
MaLoTu , it is aicpa sample exam test question. Yes it is real exam question. Your overall planning materiality applies to the financial statements, but your performance materiality applies to your testing sample.
Unless I'm remembering wrong, been a few years since I took audit and we use completely different terminology at my firm. But it sounded right when I typed it, so I'll hit submit anyway.
Don't have a login? Click here to register. Difference between Materiality and Performance Materiality This topic has 9 replies, 7 voices, and was last updated 3 years, 7 months ago by LongShot.
The amount of performance materiality is considered necessary to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements is greater than materiality. Performance materiality does not have to be set for all individual accounts as this can be done for a selected set of accounts or for a particular class of accounts. Determination of performance materiality is conducted for the purpose of assessing audit risk.
ABC Ltd. The difference between materiality and performance materiality depends on allowing a fair and objective representation of financial statements free of material misstatements materiality and the level of materiality acceptable for individual accounts performance materiality.
Both materiality and performance materiality may be subjected to change over time; for example, if the auditor determines that a lower materiality for the financial statements than what was initially determined is appropriate, performance materiality can also be changed accordingly.
Reference: 1. So how do we do this? We begin by computing materiality. In order to compute audit materiality, we must first decide which benchmark is best. Examples include total revenues, total assets, and net income. We select a benchmark that is relevant to financial statement users and stable over time.
Often total assets or total revenues are good choices. Net income. Zero net income gives you little to work with. Net income can, however, be appropriate for some entities. Once the benchmark is selected, we need to apply a percent to compute materiality.
Most CPAs use percentages in materiality forms provided by third-party publishers; others create their own. Either way, auditors must provide reasonable assurance that the financial statements are fairly stated. So, materiality and the related percentages need to be sufficiently low.
There are no magical percentages, but an excessively high materiality can lead to an improper audit opinion. Moreover, materiality is proportional. Even with a good materiality number, uncorrected and undetected misstatements can create problems.
The total of undetected errors may exceed materiality. Well, an aggregate material misstatement is present. In such a situation, the auditor might think the financial statements are fairly stated, but they are not. Because uncorrected and undetected errors are sometimes material, we need a cushion, a number less than materiality. Something to protect us. And what is that cushion? Performance materiality. This number is usually less than overall audit materiality and applies to transaction classes, account balances, and disclosures.
AU-C A14 describes performance materiality in the following manner:. Performance materiality is set to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements in the financial statements exceeds materiality for the financial statements as a whole. Similarly, performance materiality relating to a materiality level determined for a particular class of transactions, account balance, or disclosure is set to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements in that particular class of transactions, account balance, or disclosure exceeds the materiality level for that particular class of transactions, account balance, or disclosure.
As you can see, performance materiality calls for materiality thresholds at the transaction class, account balance, and disclosure level. Why the range? Different risk levels for different clients. If you believe the risk of undetected misstatements is high, then use a lower percent e.
Likewise, if your client is not inclined to record detected errors, lower the percent. Remember your goal: the combined undetected error and uncorrected misstatements must be less than materiality—both for the statements as a whole and for classes of transactions, account balances, and disclosures.
As we perform an audit, we need to summarize uncorrected misstatements. Performance materiality is considered 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 a parent company has multiple subsidiaries that are material to the overall business, then the group audit team will have component audit teams to performs audit of those subsidiaries. Audit risk has an inverse relationship with materiality.
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