Calculating

Planning
Materiality
Choose
a set of
figures
Choices
Prior year
audited figures
reliable
may not indicate current level
of trading performance
Current year
unaudited figures
unaudited
may contain material
misstatement
May use prior year figures adjusted for
trading movement in the current year
Choose a
benchmark
Choices
Turnover
reflects volume of trading activity
good indicator of level of operations
across most businesses
Gross
Assets
useful in manufacturing environments
useful where "return on assets"
is an important ratio
Operating profit
before tax
not necessarily a measure of
trading performance
not the most "stable" base
useful where "return on equity
investment" is important (listed
company)
Need to select the benchmark that reflects what
users are most likely to be interested in
May select more than one (if there are more than 1 that
are relevant) and average / weighted average them
Calculate
the range
Choices
Turnover - 0.5% to 1%
Gross Assets - 1% to 2%
Profit - 5% to 10%
These are the ones most commonly used in practice - they
are however not prescription (there is nothing in the ISA
prescribing %'s) and audit firms may use different ranges
Having chosen the benchmark, you
calculate the range based on these %'s
Set a
level
within
the
range
Choices
Adjust for user sensitivity to misstatement
Adjust for overall level of audit risk
User
sensitivity
the more sensitive we believe that users
may be toward material misstatement,
the lower the materiality will be set
(towards the bottom end of the range)
the less sensitive we believe that users
may be toward material misstatement,
the higher the materiality will be set
(towards the top end of the range)
Audit risk
The higher the overall audit risk, the
lower the planning materiality needs to
be (to reduce levels of overall detection
risk in order to reduce overall audit risk
back to acceptable levels)
The lower the overall audit risk, the
higher the planning materiality can be
(to increase levels of overall detection
risk in order to increase overall audit risk
back to acceptable levels)
Note that this adjustment for risk is
discretionary and is one of the several
possible responses to overall audit risk
Calculate
Performance
Materiality
Once you have set planning materiality, you then
set the level of acceptable misstatement in the
account balances ("Performance materiality")
This is the level of acceptable error in the
individual account balances, which is set at a level
below planning materiality to take into account the
cumulative effect of uncorrected misstatement
Performance materiality will be a set % of planning
materiality (usually in the region of about 70%).
Calculate the level of
error to be regarded
as "Clearly Trivial"
Also a set % of planning materiality
(usually around 3 to 5%)
this determines the level of misstatement
below which identified misstatements are
essentially ignored on the basis that they
cannot individually (or cumulatively) affect
decisions taken by users on a set of AFS
Calculation of Planning Materiality.mmap - 2011/03/22 -