MATERIALITY IN THE AUDIT OF FINANCIAL STATEMENTS
13
The auditors have designed a test for accounts receivable which involves two methods
of selecting items for testing (based on ISA 500.A52):
1. selecting some specific items for testing (based on their size and/or risk); and
2. taking a sample of items from the remaining population.
Misstatements have been identified both in the specific items tested and in the sample.
The misstatements in the sample have been projected to determine the potential
misstatement in the population:
Total population: £5,000,000 (456 items)
1. Specific items selected prior to sampling: £890,000 (10 items). Misstatements
identified by testing = £3,400 (this represents a factual misstatement and as no
sampling has been involved here it is not appropriate to extrapolate these findings)
2. Sampling: value of items included in sample = £474,000. Misstatements in items
sampled = £1,290
Projected misstatement = £9,895 [£1,290/£474,000 * (£5,000,000 – £890,000 – £474,000)]
For inclusion on summary of misstatements:
Factual misstatements = £3,400 + £1,290
Projected misstatements = £9,895
The auditors request entity management to correct any factual misstatement(s) found (ISA
450.8) and will have discussions with management regarding differences in judgement
in order to agree whether an adjustment is needed. But it will be difficult to persuade
management that financial statements should be ‘corrected’ for a projected misstatement
as, given the sampling risk, there can be no certainty that the projected misstatement
represents the true misstatement in the population. Where the projected misstatement, in
combination with other identified misstatements, is below overall materiality, the auditors
can still conclude that the financial statements are not materially misstated. But where overall
materiality is exceeded, the auditors have a problem as the financial statements could be
materially misstated. Auditors may also need to consider if, for example, the combination of
the projected misstatement and other identified misstatements is below overall materiality
but very close to it (given the increased risk of uncorrected misstatements and undetected
misstatements exceeding materiality). In these cases, they have two options – either to request
management to investigate the population (and then to check the results of management’s
work), or to perform sufficient additional testing directly in order to reduce the impact of any
projected misstatement.
ASSESSING THE MATERIALITY OF MISSTATEMENTS
Having accumulated the various factual, judgemental and projected misstatements on the
summary of misstatements, auditors determine whether uncorrected misstatements are
material, individually or in aggregate, as required by ISA 450.11.
According to ISA 450.A16 ‘Each individual misstatement of an amount is considered to
evaluate its effect on the relevant classes of transactions, account balances or disclosures,
including whether the materiality level for that particular class of transactions, account balance
or disclosure, if any, has been exceeded’.
In assessing whether misstatements are material, the auditors need to consider both the size
and the nature of those misstatements.
In terms of the size of misstatements, this means considering whether the quantitative
amounts of those misstatements exceed overall materiality (or lower specific materiality). But
that’s not enough. It is not just a simple quantitative assessment of whether £X exceeds £Y.
There are a number of issues that auditors may need to consider, including:
• qualitative assessment;
• balance sheet misclassifications;