The concepts of materiality included in SAS No. 107 provide a framework for audit quality. They also provide opportunities for saving time. Here are some of the time savings opportunities:
• Tolerable misstatement by financial statement classification will affect sample sizes determined statistically or non-statistically. Using a higher level of tolerable misstatement when risk at the assertion level is low or medium results in fewer individually significant items, smaller sample sizes and less audit work to achieve the desired level of assurance.
• Using a factor of up to 1/3 (or maybe higher!) of tolerable misstatement at the financial statement or assertion levels to determine the lower limit for individually significant items when risk is less than high to moderate at the financial statement level allows us to eliminate work by auditing fewer individually significant items. Account balances on the trial balance, individual accounts receivable balances or outstanding checks on bank reconciliations that are less than the respective lower limit are examples of details that can be excluded from testing.
• Potential adjustments less than the lower limit can be recorded on an Error Analysis Form (called Audit Difference Evaluation Form by some publishers) for error analysis by the in-charge accountant, thereby limiting the number of proposed adjustments to the trial balance.
• Immaterial paper-passed adjustments require no further consideration or documentation.
Thinking outside the Forms
Most firms calculate a dollar amount for planning materiality and tolerable misstatement on audits. Since a calculation is not required by professional standards, some have made decisions to subjectively evaluate materiality by account balance as either high or low depending on engagement risks. Most staff auditors, however, follow the practice aids used in their firm’s quality control system to calculate materiality levels.
In addition to complying with professional standards, a principal objective on all audits is to achieve maximum profitability. We must ever be in search of opportunities to accomplish this objective. Learning to think outside standard approaches by using our common sense and professional judgment in each engagement’s circumstances will enable us to comply with professional standards and, at the same time, achieve the highest level of profitability. Calculating and using tolerable misstatement and the lower limit for individually significant items at both the financial statement level and for material account classifications based on risk, for example, will help us accomplish both objectives. This is the process of exercising professional judgment. Good professional judgment maximizes profits!
My live and on-demand webcast series entitled Staff Training for New In-Charge Accountants contains information on how to establish materiality levels based on risk. You can download syllabuses or register for these and other webcasts by clicking the applicable box on the left side of my home page, www.cpafirmsupport.com.