Back to basics: Materiality thresholds
Are you comfortable with the basics of establishing materiality in audits? In the conclusion of our Materiality Back to Basics articles, we look at other thresholds used during the course of the audit engagement.
Particular Items Materiality
Specific classes of transactions, account balances or disclosures within a set of financial statements may be the focus of greater scrutiny by the users of the financial statements.
This just means that there may be figures or areas within the financial statements that are of particular interest to the users, because they provide insight into company performance or because they disclose sensitive information (for example directors’ remuneration disclosures).
Therefore, such areas may be assigned a separate, lower materiality level to incorporate the influence errors or omissions in that specific area may have on the users.
The auditor is required to record, consider and report all misstatements identified in the course of the audit other than those considered ‘clearly trivial’. This is normally a small percentage of overall materiality and generally means that the auditor can ignore any errors or omissions below this level, as they are so small they are considered negligible.
Component materiality is specific to group audits. In a group audit, the auditor will ‘scope’ the components within the group that are considered significant and therefore require more in-depth audit procedures.
Materiality, alongside other factors such as risk, will be used to make this decision. As with performance materiality, this application of materiality creates the risk that there are undetected and uncorrected misstatements that, in aggregate, are material.
Because the auditor is not checking every single transaction within the group, there is a risk of small, undetected errors that together are material
To reduce this risk, the group audit team will assign a component materiality to each component within the group. The auditing standards specifically state that component materiality should be set at a lower level than the overall materiality for the group financial statements. The level set is often influenced by the size and risk of the component.