ASA 320
(October 2009)
Auditing Standard 320
Materiality in Planning and Performing an Audit
Issued by the Auditing and Assurance Standards Board
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ISSN 1833-4393
CONTENTS
PREFACE
AUTHORITY STATEMENT
Paragraphs
Application..................................................................................... .. Aus 0.1-Aus 0.2
Operative Date............................................................................... ................. Aus 0.3
Introduction
Scope of this Auditing Standard.............................................................................. 1
Materiality in the Context of an Audit.................................................................. 2-6
Effective Date............................................................................................................... 7
Objective....................................................................................................................... 8
Definition..................................................................................................................... 9
Requirements
Determining Materiality and Performance Materiality When Planning the Audit 10-11
Revision as the Audit Progresses..................................................................... 12-13
Documentation.......................................................................................................... 14
Application and Other Explanatory Material
Materiality and Audit Risk........................................................... ....... A1-Aus A1.1
Determining Materiality and Performance Materiality When Planning the Audit A2-A12
Revision as the Audit Progresses....................................................................... A13
Conformity with International Standards on Auditing
Preface
Reasons for Issuing Auditing Standard ASA 320 Materiality in Planning and Performing an Audit
The Auditing and Assurance Standards Board (AUASB) issues Auditing Standard ASA 320 Materiality in Planning and Performing an Audit pursuant to the requirements of the legislative provisions and the Strategic Direction explained below.
The AUASB is an independent statutory board of the Australian Government under section 227A of the Australian Securities and Investments Commission Act 2001, as amended (ASIC Act). Under section 336 of the Corporations Act 2001, the AUASB may make Auditing Standards for the purposes of the corporations legislation. These Auditing Standards are legislative instruments under the Legislative Instruments Act 2003.
Under the Strategic Direction given to the AUASB by the Financial Reporting Council (FRC), the AUASB is required to have regard to any programme initiated by the International Auditing and Assurance Standards Board (IAASB) for the revision and enhancement of the International Standards on Auditing (ISAs) and to make appropriate consequential amendments to the Australian Auditing Standards. Accordingly, the AUASB has decided to revise and redraft the Australian Auditing Standards using the equivalent redrafted ISAs.
Main Features
This Auditing Standard establishes requirements and provides application and other explanatory material regarding the auditor’s responsibility to apply the concept of materiality in planning and performing an audit of a financial report.
This Auditing Standard requires the auditor to:
(a) exercise professional judgement to determine materiality (including performance materiality) when planning the audit;
(b) revise materiality as the audit progresses if the auditor considers it necessary; and
(c) document the factors used by the auditor in determining or revising materiality.
AUTHORITY STATEMENT
The Auditing and Assurance Standards Board (AUASB) makes this Auditing Standard ASA 320 Materiality in Planning and Performing an Audit pursuant to section 227B of the Australian Securities and Investments Commission Act 2001 and section 336 of the Corporations Act 2001.
This Auditing Standard is to be read in conjunction with ASA 101 Preamble to Australian Auditing Standards, which sets out the intentions of the AUASB on how the Australian Auditing Standards, operative for financial reporting periods commencing on or after 1 January 2010, are to be understood, interpreted and applied. This Auditing Standard is to be read also in conjunction with ASA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Australian Auditing Standards.
Dated: 27 October 2009 M H Kelsall
Chairman - AUASB
Auditing Standard ASA 320
Materiality in Planning and Performing an Audit
Application
Aus 0.1 This Auditing Standard applies to:
(a) an audit of a financial report for a financial year, or an audit of a financial report for a half-year, in accordance with the Corporations Act 2001; and
(b) an audit of a financial report, or a complete set of financial statements, for any other purpose.
Aus 0.2 This Auditing Standard also applies, as appropriate, to an audit of other historical financial information.
Operative Date
Aus 0.3 This Auditing Standard is operative for financial reporting periods commencing on or after 1 January 2010.
Introduction
Scope of this Auditing Standard
1. This Auditing Standard deals with the auditor’s responsibility to apply the concept of materiality in planning and performing an audit of a financial report. ASA 450[1] explains how materiality is applied in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial report.
Materiality in the Context of an Audit
2. Financial reporting frameworks often discuss the concept of materiality in the context of the preparation and presentation of a financial report. Although financial reporting frameworks may discuss materiality in different terms, they generally explain that:
· Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial report;
· Judgements about materiality are made in light of surrounding circumstances, and are affected by the size or nature of a misstatement, or a combination of both; and
· Judgements about matters that are material to users of the financial report are based on a consideration of the common financial information needs of users as a group.[2] The possible effect of misstatements on specific individual users, whose needs may vary widely, is not considered.
3. Such a discussion, if present in the applicable financial reporting framework, provides a frame of reference to the auditor in determining materiality for the audit. If the applicable financial reporting framework does not include a discussion of the concept of materiality, the characteristics referred to in paragraph 2 of this Auditing Standard provide the auditor with such a frame of reference.
4. The auditor’s determination of materiality is a matter of professional judgement, and is affected by the auditor’s perception of the financial information needs of users of the financial report. In this context, it is reasonable for the auditor to assume that users:
(a) Have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information in the financial report with reasonable diligence;
(b) Understand that the financial report is prepared, presented and audited to levels of materiality;
(c) Recognise the uncertainties inherent in the measurement of amounts based on the use of estimates, judgement and the consideration of future events; and
(d) Make reasonable economic decisions on the basis of the information in the financial report.
5. The concept of materiality is applied by the auditor both in planning and performing the audit, and in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial report and in forming the opinion in the auditor’s report. (Ref: Para. A1)
6. In planning the audit, the auditor makes judgements about the size of misstatements that will be considered material. These judgements provide a basis for:
(a) Determining the nature, timing and extent of risk assessment procedures;
(b) Identifying and assessing the risks of material misstatement; and
(c) Determining the nature, timing and extent of further audit procedures.
The materiality determined when planning the audit does not necessarily establish an amount below which uncorrected misstatements, individually or in the aggregate, will always be evaluated as immaterial. The circumstances related to some misstatements may cause the auditor to evaluate them as material even if they are below materiality. Although it is not practicable to design audit procedures to detect misstatements that could be material solely because of their nature, the auditor considers not only the size but also the nature of uncorrected misstatements, and the particular circumstances of their occurrence, when evaluating their effect on the financial report.[3]
Effective Date
7. [Deleted by the AUASB. Refer Aus 0.3]
Objective
8. The objective of the auditor is to apply the concept of materiality appropriately in planning and performing the audit.
Definition
9. For purposes of the Australian Auditing Standards, performance materiality means the amount or amounts set by the auditor at less than materiality for the financial report as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial report as a whole. If applicable, performance materiality also refers to the amount or amounts set by the auditor at less than the materiality level or levels for particular classes of transactions, account balances or disclosures.
Requirements
Determining Materiality and Performance Materiality When Planning the Audit
10. When establishing the overall audit strategy, the auditor shall determine materiality for the financial report as a whole. If, in the specific circumstances of the entity, there is one or more particular classes of transactions, account balances or disclosures for which misstatements of lesser amounts than materiality for the financial report as a whole could reasonably be expected to influence the economic decisions of users taken on the basis of the financial report, the auditor shall also determine the materiality level or levels to be applied to those particular classes of transactions, account balances or disclosures. (Ref: Para. A2-A11)
11. The auditor shall determine performance materiality for purposes of assessing the risks of material misstatement and determining the nature, timing and extent of further audit procedures. (Ref: Para. A12)
Revision as the Audit Progresses
12. The auditor shall revise materiality for the financial report as a whole (and, if applicable, the materiality level or levels for particular classes of transactions, account balances or disclosures) in the event of becoming aware of information during the audit that would have caused the auditor to have determined a different amount (or amounts) initially. (Ref: Para. A13)
13. If the auditor concludes that a lower materiality for the financial report as a whole (and, if applicable, materiality level or levels for particular classes of transactions, account balances or disclosures) than that initially determined is appropriate, the auditor shall determine whether it is necessary to revise performance materiality, and whether the nature, timing and extent of the further audit procedures remain appropriate.
Documentation
14. The auditor shall include in the audit documentation the following amounts and the factors considered in their determination[4]:
(a) Materiality for the financial report as a whole (see paragraph 10 of this Auditing Standard);
(b) If applicable, the materiality level or levels for particular classes of transactions, account balances or disclosures (see paragraph 10 of this Auditing Standard);
(c) Performance materiality (see paragraph 11 of this Auditing Standard); and
(d) Any revision of (a)-(c) as the audit progressed (see paragraphs 12-13 of this Auditing Standard).
* * *
Application and Other Explanatory Material
Materiality and Audit Risk (Ref: Para. 5)
A1. In conducting an audit of a financial report, the overall objectives of the auditor are to obtain reasonable assurance about whether the financial report as a whole is free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial report is prepared, in all material respects, in accordance with an applicable financial reporting framework; and to report on the financial report, and communicate as required by the Australian Auditing Standards, in accordance with the auditor’s findings.[5] The auditor obtains reasonable assurance by obtaining sufficient appropriate audit evidence to reduce audit risk to an acceptably low level.[6] Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial report is materially misstated. Audit risk is a function of the risks of material misstatement and detection risk.[7] Materiality and audit risk are considered throughout the audit, in particular, when:
(a) Identifying and assessing the risks of material misstatement;[8]
(b) Determining the nature, timing and extent of further audit procedures;[9] and
(c) Evaluating the effect of uncorrected misstatements, if any, on the financial report[10] and in forming the opinion in the auditor’s report.[11]
Aus A1.1 Australian Accounting Standards* explain the role of materiality in making judgements in the preparation and presentation of a financial report by the entity.
Determining Materiality and Performance Materiality When Planning the Audit
Considerations Specific to Public Sector Entities (Ref: Para. 10)
A2. In the case of a public sector entity, legislators and regulators are often the primary users of its financial report. Furthermore, the financial report may be used to make decisions other than economic decisions. The determination of materiality for the financial report as a whole (and, if applicable, materiality level or levels for particular classes of transactions, account balances or disclosures) in an audit of the financial report of a public sector entity is therefore influenced by law, regulation or other authority, and by the financial information needs of legislators and the public in relation to public sector programs.
Use of Benchmarks in Determining Materiality for the Financial Report as a Whole (Ref: Para. 10)
A3. Determining materiality involves the exercise of professional judgement. A percentage is often applied to a chosen benchmark as a starting point in determining materiality for the financial report as a whole. Factors that may affect the identification of an appropriate benchmark include the following:
· The elements of the financial report (for example, assets, liabilities, equity, revenue, expenses);
· Whether there are items on which the attention of the users of the particular entity’s financial report tends to be focused (for example, for the purpose of evaluating financial performance users may tend to focus on profit, revenue or net assets);
· The nature of the entity, where the entity is in its life cycle, and the industry and economic environment in which the entity operates;
· The entity’s ownership structure and the way it is financed (for example, if an entity is financed solely by debt rather than equity, users may put more emphasis on assets, and claims on them, than on the entity’s earnings); and
· The relative volatility of the benchmark.
A4. Examples of benchmarks that may be appropriate, depending on the circumstances of the entity, include categories of reported income such as profit before tax, total revenue, gross profit and total expenses, total equity or net asset value. Profit before tax from continuing operations is often used for profit-oriented entities. When profit before tax from continuing operations is volatile, other benchmarks may be more appropriate, such as gross profit or total revenues.
A5. In relation to the chosen benchmark, relevant financial data ordinarily includes prior periods’ financial results and financial positions, the period-to-date financial results and financial position, and budgets or forecasts for the current period, adjusted for significant changes in the circumstances of the entity (for example, a significant business acquisition) and relevant changes of conditions in the industry or economic environment in which the entity operates. For example, when, as a starting point, materiality for the financial report as a whole is determined for a particular entity based on a percentage of profit before tax from continuing operations, circumstances that give rise to an exceptional decrease or increase in such profit may lead the auditor to conclude that materiality for the financial report as a whole is more appropriately determined using a normalised profit before tax from continuing operations figure based on past results.
A6. Materiality relates to the financial report on which the auditor is reporting. Where the financial report is prepared for a financial reporting period of more or less than twelve months, such as may be the case for a new entity or a change in the financial reporting period, materiality relates to the financial report prepared for that financial reporting period.
A7. Determining a percentage to be applied to a chosen benchmark involves the exercise of professional judgement. There is a relationship between the percentage and the chosen benchmark, such that a percentage applied to profit before tax from continuing operations will normally be higher than a percentage applied to total revenue. For example, the auditor may consider five percent of profit before tax from continuing operations to be appropriate for a profit-oriented entity in a manufacturing industry, while the auditor may consider one percent of total revenues or total expenses to be appropriate for a not-for-profit entity. Higher or lower percentages, however, may be deemed appropriate in the circumstances.
Considerations Specific to Small Entities
A8. When an entity’s profit before tax from continuing operations is consistently nominal, as might be the case for an owner-managed business where the owner takes much of the profit before tax in the form of remuneration, a benchmark such as profit before remuneration and tax may be more relevant.
Considerations Specific to Public Sector Entities
A9. In an audit of a public sector entity, total cost or net cost (expenses less revenues or expenditure less receipts) may be appropriate benchmarks for program activities. Where a public sector entity has custody of public assets, assets may be an appropriate benchmark.
Materiality Level or Levels for Particular Classes of Transactions, Account Balances or Disclosures (Ref: Para. 10)
A10. Factors that may indicate the existence of one or more particular classes of transactions, account balances or disclosures for which misstatements of lesser amounts than materiality for the financial report as a whole could reasonably be expected to influence the economic decisions of users taken on the basis of the financial report include the following:
· Whether law, regulation or the applicable financial reporting framework affect users’ expectations regarding the measurement or disclosure of certain items (for example, related party transactions, and the remuneration of management and those charged with governance).
· The key disclosures in relation to the industry in which the entity operates (for example, research and development costs for a pharmaceutical company).
· Whether attention is focused on a particular aspect of the entity’s business that is separately disclosed in the financial report (for example, a newly acquired business).
Aus A10.1 In certain circumstances, an entity may be required to make disclosures in the financial report that are not subject to materiality.*
A11. In considering whether, in the specific circumstances of the entity, such classes of transactions, account balances or disclosures exist, the auditor may find it useful to obtain an understanding of the views and expectations of those charged with governance and management.
Performance Materiality (Ref: Para. 11)
A12. Planning the audit solely to detect individually material misstatements overlooks the fact that the aggregate of individually immaterial misstatements may cause the financial report to be materially misstated, and leaves no margin for possible undetected misstatements. Performance materiality (which, as defined, is one or more amounts) is set to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements in the financial report exceeds materiality for the financial report as a whole. Similarly, performance materiality relating to a materiality level determined for a particular class of transactions, account balance or disclosure is set to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements in that particular class of transactions, account balance or disclosure exceeds the materiality level for that particular class of transactions, account balance or disclosure. The determination of performance materiality is not a simple mechanical calculation and involves the exercise of professional judgement. It is affected by the auditor’s understanding of the entity, updated during the performance of the risk assessment procedures; and the nature and extent of misstatements identified in previous audits and thereby the auditor’s expectations in relation to misstatements in the current period.
Revision as the Audit Progresses (Ref: Para. 12)
A13. Materiality for the financial report as a whole (and, if applicable, the materiality level or levels for particular classes of transactions, account balances or disclosures) may need to be revised as a result of a change in circumstances that occurred during the audit (for example, a decision to dispose of a major part of the entity’s business), new information, or a change in the auditor’s understanding of the entity and its operations as a result of performing further audit procedures. For example, if during the audit it appears as though actual financial results are likely to be substantially different from the anticipated period end financial results that were used initially to determine materiality for the financial report as a whole, the auditor revises that materiality.
Conformity with International Standards on Auditing
This Auditing Standard conforms with International Standard on Auditing ISA 320 Materiality in Planning and Performing an Audit, issued by the International Auditing and Assurance Standards Board (IAASB), an independent standard-setting board of the International Federation of Accountants (IFAC).
Paragraphs that have been added to this Auditing Standard (and do not appear in the text of the equivalent ISA) are identified with the prefix “Aus”.
Compliance with this Auditing Standard enables compliance with ISA 320.
[1] See ASA 450 Evaluation of Misstatements Identified during the Audit.
[2] See, for example, the AASB’s Framework for the Preparation and Presentation of Financial Statements (July 2004).
[3] See ASA 450, paragraph A16.
[4] See ASA 230 Audit Documentation, paragraphs 8-11 and paragraph A6.
[5] See ASA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Australian Auditing Standards, paragraph 11.
[6] See ASA 200, paragraph 17.
[7] See ASA 200, paragraph 13(c).
[8] See ASA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment.
[9] See ASA 330 The Auditor’s Responses to Assessed Risks.
[10] See ASA 450.
[11] See ASA 700 Forming an Opinion and Reporting on a Financial Report.
* See Accounting Standard AASB 1031 Materiality.
* See, for example, sections 300 and 300A of the Corporations Act 2001 and Australian Accounting Standards.
