Guide to Using International Standards on Auditing in - IFAC

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<strong>Guide</strong> <strong>to</strong> <strong>Using</strong> <strong>International</strong> <strong>Standards</strong> on Auditing in the Audits of Small- and Medium-Sized Entities Volume 1—Core Concepts
Audi<strong>to</strong>rs are sometimes tempted <strong>to</strong> lower the overall materiality amount when the risk of material
misstatement is assessed as high. This would not be appropriate, however, as overall materiality addresses the
needs of financial statements users, not the level of audit risk involved.
If audit risk was a fac<strong>to</strong>r in setting overall materiality, a high-risk audit would end up with a lower overall
materiality amount than that set for a similar-sized entity where audit risk was low. Assuming that the
information needs of financial statement users are the same, regardless of audit risk, setting the overall
materiality amount at a lower level would result in:
• Providing financial statement users with an expectation that smaller misstatements in the financial
statements (than is actually necessary) will be identified by the audi<strong>to</strong>r; and
• Additional audit work <strong>to</strong> ensure that audit risk has been reduced <strong>to</strong> an appropriately low level.
Because overall materiality is set in relation <strong>to</strong> the needs of financial statement users, it would not be changed
as a result of audit findings and changes in assessed risks. Overall materiality is required <strong>to</strong> be updated when
the audi<strong>to</strong>r becomes aware of information that would have caused the initial determination of materiality <strong>to</strong>
be a different amount (or amounts).
At the conclusion of the audit, overall materiality will be used for evaluating the effect of identified
misstatements on the financial statements and the appropriateness of the opinion in the audi<strong>to</strong>r’s report.
Performance Materiality
Performance materiality allows the audi<strong>to</strong>r <strong>to</strong> address the risks of misstatement in account balances, classes
of transactions, and disclosures without having <strong>to</strong> change overall materiality. Performance materiality
enables the audi<strong>to</strong>r <strong>to</strong> establish materiality amounts that are based on the overall materiality, but are set at
lower amounts <strong>to</strong> reflect the risk of not detecting misstatements and <strong>to</strong> reflect risk assessments. This lower
amount(s) establishes a safety buffer between the materiality used for determining the nature and extent of
testing (performance materiality) and the materiality amount for the financial statements as a whole (overall
materiality).
Setting an appropriate amount for performance materiality will ensure that more work is performed, which
increases the likelihood that misstatements (if they exist) will be identified. For example, if overall materiality
was 20,000Є and audit procedures were planned <strong>to</strong> detect all errors in excess of 20,000Є, it is quite possible
that an error of, say, 8,000Є would go undetected. If three such errors existed, amounting <strong>to</strong> 24,000Є, the
financial statements would be materially misstated. However, if performance materiality was set at 12,000Є, it
would be much more likely that at least one or all of the 8,000Є errors would be detected. Even if only one of
the three errors was identified and corrected, the remaining misstatement of 16,000Є would be less than the
overall materiality, and the financial statements as a whole would not be materially misstated.
Setting an appropriate amount for performance materiality involves the exercise of professional judgment,
and is not a simple mechanical calculation such as a percentage (e.g., 75%) of the overall materiality level.
However, based on the particular circumstances of the entity being audited, it could be set as a single amount
for the financial statements as a whole, or at individual amounts for particular balances, transactions, and
disclosures.