Three Steps to Determining and Applying Materiality
What is Materiality?
Materiality is an amount that makes a difference to the users- an audit never provides 100% assurance- only “reasonable assurance." For instance, if a company has overstated its revenues by $5million when its total revenues are $4 billion, then this $5 million is considered 'immaterial.' However, if the company's total revenues are only $50 million, then this $5 million overstatement is considered 'Material."
1. Determine a base and calculate a number.
•5% of income from continuing operations (normalized)
•5% of net income before bonus,
•½ to 2% of revenues or expenses for non-for profit entities,
•½ to 1% of net asset value for the mutual fund industry, or
•1% of revenue for the real estate industry.
Note: Materiality is a matter of Professional Judgement so:
• When profit before tax from continuing operations is volatile, other benchmarks may be more appropriate, such as gross profit or total revenues but for most for profit enterprises, income from continuing operations is the most appropriate.
Once a preliminary figure is calculated- then consider qualitative items i.e.
2. During the audit, auditors track the misstatements on the SUE- Summary of Unadjusted Errors
3. Estimate the likely misstatement and compare the total to the preliminary materiality.