Chapter 9 - Materiality

Preliminary materiality pre designed table method n

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+ Preliminary Materiality: Pre-Designed Table Method n Using Preliminary Materiality Sliding Scale Table n Example – Wal-Mart n Base – Revenues = $418.952 Billion n On the scale revenues fall above $300 Billion n $82.6 Million (Base) n $17.6 Million (Excess Factor) n Total Preliminary Materiality = $100.2 Million
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+ Planning Materiality: Allocation of Preliminary Materiality n Tolerable Misstatement n An estimate of the maximum monetary misstatement that may exist in an account balance without causing the financial statements to be materially misstated. n Allocation of Preliminary Materiality n Allocating the overall materiality to account balances to give us tolerable misstatement levels for accounts. n Points about Tolerable Misstatement: n Allocated only to accounts not audited 100% n Allocated to both balance sheet and income
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+ Planning Materiality: Allocation of Preliminary Materiality n Words of Caution
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+ Allocation of Preliminary Materiality n Two Main Approaches:
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+ Allocation of Preliminary Materiality: Rule of Thumb n Allocate 50% to 75% of preliminary materiality to each account. n Account’s tolerable misstatement (TM) could add up to 3 to 4 times the preliminary materiality. n Why? n Not all accounts will be misstated by their TM. n Simultaneous audit of accounts. n TM as percentage of PM is usually a very small amount for large accounts. n PM is a safety net. n Achieve smaller TM during testing.
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+ Example – Rule of Thumb Approach Accounts Amount Allocation % Tolerable misstatement (TM) Cash $500,000 Audited 100% A/R $2,000,000 50% PPE $500,000 Audited 100% Investments $3,000,000 60% Inventory $4,000,000 75% Total assets $10,000,000 Step 1 – Determine Preliminary Materiality Base – Total assets = 10,000,000
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