Chapter 9 - Materiality

Our audit procedures to detect only material

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our audit procedures to detect only material misstatements (and don’t waste time looking for immaterial misstatements): n Which accounts and items to look at. n How many items to look at. n As an evaluation tool to determine whether the financial statements require adjustment in order to be fairly stated (in accordance with GAAP).
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+ Determining Preliminary Materiality n Overall materiality level for the company. n How do we determine it? n Consider important factors n Size of the company ( Quantitative ) n History of misstatement n History of relationship with client n Nearness to critical points n Breakeven point n Debt covenants Qualitative n Bonus cutoffs n Trends n Analyst forecasts
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+ Determining Preliminary Materiality n Two Main Approaches:
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+ Determining Preliminary Materiality n To compute preliminary materiality, consider the important items (slide seven) and select: n A base n Base (size) = f (user relevance, stability) n A percentage n Percentage (sensitivity) = f (size of client, qualitative factors)
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+ Preliminary Materiality: Rule of Thumb Method n Rules of Thumb: n Assets/Revenues x 0-5% n GM/NI/Avg NI x 5-10% n SEC has indicated that anything greater than 5% of NI is material n Often will use Revenue or Expense for NFP organizations
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+ Preliminary Materiality: Rule of Thumb Method Example n Wal-Mart n Net Income = $16.389 Billion X 5% = $819 Million n Base 3% n Users – public company – mostly investors : Revenues or NI n Stability – both stable can do NI – investors can about this n Percentage +2% n Very Large – smaller percentage n Good History – larger percentage n Critical Points Closeness – no – larger percentage
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