ACC 139 Auditing and Assurance Principles

Student Activity Sheet #6

Name: _____________________________________________________________ Class number: _______

Section: ____________ Schedule: ______________________________________ Date: ______________

Lesson title: Determining Materiality Materials:

Lesson Objectives: Student Activity Sheets
1. Explain the concept of materiality, including its application

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to the audit References:

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2. Discuss the application of materiality to the three audit Auditing-A Risk-Based
phases, including its relationship to audit procedures, audit Approach Part 1 – Theory by:

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evidence, and audit risk. Leomar Cabarles/Reynaldo
Ocampo/Rommel Valdez

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Start where you are. Use what you have. Do what you can. – Arthur Ashe

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A. LESSON PREVIEW/REVIEW
1) Introduction
Greetings Buddy! Do you know when something is material or not? In your life which are the

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things are material to you and which is not? I know you already have a clue about materiality in
financial accounting. So, let’s start learning it on the auditor’s perspective.
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2) Activity 1: What I Know Chart
What do you know about Auditing? Try answering the questions below by writing your ideas under
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the What I Know column. You may use key words or phrases that you think are related to the
questions.

What I Know Questions: What I Learned (Activity 4)

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What is the relationship between

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materiality and audit procedures?

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Is materiality relative or fix?

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Why do we need materiality?

 ACC 139 Auditing and Assurance Principles
Student Activity Sheet #6

B. MAIN LESSON
Activity 2: Content Note

Materiality is the maximum misstatement in the FS that could affect the decision of the user. It is
relative as to size and nature. For example, P10,000 misstatement in sales may be material to a
company with a P50,000 total sales but not with a P500,000 sales (Size). Further if the misstatement is

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due to fraud, we may consider it as material depending on our professional judgement (Nature).

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The users of F/S make economic decisions based on the information provided by the F/S. Our ultimate
goal is to opine if the F/S is presented fairly in all material respect. Since we only offer reasonable

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assurance, we are only required to make audit procedures on material items since only material items
can affect the economic decisions of the users.

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Alpha Risk vs, Beta Risk

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Since materiality is based on professional judgement and estimate of the auditor, it may be assessed
too low that may lead to (alpha risk) or too high (beta risk).

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• Alpha risk – since materiality is inversely related to our audit procedure, too low materiality may
lead us to do unnecessary audit procedures. Our effort and resources were unnecessarily wasted
😢. This means that our efficiency in audit was compromised.

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• Beta risk – in this case, too high materiality may lead us to except material item that should have
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been tested. This means the effectivity of audit was compromised that may lead us to incorrect
audit opinion.
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Materiality Vs. Audit Procedures and Evidence

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Materiality has an inverse relationship with audit procedures and evidence.

Scenario: The entity has the following sales:
1 132,500 5 125,000 If we assessed the materiality to 150,000, we will be
conducting procedures to sales number 2 and 8. But
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2 150,000 6 120,000 if it is assessed to 125,000, sales number 1,2,5, and

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3 110,000 7 123,500 8 will qualify for our testing. Therefore, we will be

needing to gather more evidence and conduct more
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4 100,000 8 173,750 procedures to test the sales.

Three Different Levels of Materiality

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1. Materiality for FS as a whole (General Materiality/Planning Materiality or PM)

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a. Determined at the overall FS level

b. Basis of the auditor to decide whether proposed audit engagement is significant or not
c. Required steps:
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i. Determine appropriate benchmark (e.g. for startup entity, expenses may be the
appropriate benchmark since startup business rarely generates revenue and has a lot of
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startup expenses.
ii. Choose appropriate percentage (the lower percentage, the more extensive procedures,
e.g. 5% (lower) to 8% (higher), therefore Materiality = Expenses x (8% or 5%))
2. Performance materiality (Tolerable Error or TE)
a. Calculated at a certain percentage of general materiality to capture misstatements that in
aggregate may exceed general materiality (e.g. 50% of PM)
b. Used in scoping FS line items (e.g. TE is 500,000, total PPE is 50,000, therefore it is
immaterial as to amount, not subject for testing)
 ACC 139 Auditing and Assurance Principles
Student Activity Sheet #6
3. Particular materiality
a. Amount set by the auditor for particular classes of transaction, account balances or disclosure
for misstatement that is lower than PM but may affect decision of users (immaterial as to
amount but material as to nature)
b. Factors to be considered in determining particular materiality
i. Laws and regulation
ii. Financial reporting framework

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iii. Key financial disclosures of the entity
iv. Particular aspects of the business

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v. Understanding of the view of those charged with governance

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Activity 3: Skill building
The audit team decided to use revenue as benchmark. It is the firm’s policy to use 5% to 8% of the
chosen benchmark as planning materiality and 50% t0 75% of Pm as tolerable error. The entity

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generated 500 million revenue for the year. Further we assessed that the entity is closed monitoring

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since it is a subsidiary of a PSE listed entity.
Provide the following:

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Planning materiality
Tolerable error
Particular materiality

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Using materiality above, which of the following is material as to amount (for testing). Write “Material” or
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“Immaterial”.
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Cash and cash equivalents P18,563,000
Financial assets @ fair value through profit or loss 10,000,000
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Trade and other receivables 13,680,000

Property, plant and equipment 15,560,000
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Activity 4: What I Know Chart

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Now let us check your final understanding of practitioner’s engagements. I hope that everything about
the topic is clear to you. This time you must fill out the What I Learned column.
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Activity 5: Check for Understanding

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1. Which of the following would an auditor most likely use in determining the auditor’s preliminary
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judgement about materiality?

A. The anticipated sample size of the planned substantive test
B. The entity’s annualized interim FS
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C. The result of the internal control questionnaire

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D. The contents of the management representation letter

2. The auditor is required to determine three different level of materiality. General materiality,
performance materiality and
A. Overall materiality C. Tolerable error
B. Specific materiality D. Summary of audit differences
3. What materiality level would an auditor use to determine if the proposed adjustment is significant?
A. Overall materiality C. Tolerable error
B. Specific materiality D. Summary of audit differences
4. What materiality level is used to determine which line item is material or subject for testing?
 ACC 139 Auditing and Assurance Principles
Student Activity Sheet #6
A. Overall materiality C. Performance materiality
B. Specific materiality D. Summary of audit differences
5. Which of the following statements concerning materiality is incorrect?
A. When establishing the overall audit strategy, the auditor shall determine materiality for the
financial statements as a whole.
B. 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

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for the FS are as a whole could reasonably be expected to influence the economic decisions of the users
taken on the basis of the FS, the auditor shall determine the materiality level/s to those particular items

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C. Determining materiality involves the exercise of professional judgement.
D. The materiality level for FS as a whole determined in the planning stage of the audit should

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not be affected by changes in the circumstances of the engagement.

C. LESSON WRAP UP

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You are done with this session! Let’s track your progress. Shade the session number you just

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completed.

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Activity 6: Think about learning! 🤔

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1. Please read again the learning targets for the day. Were you able to achieve those learning targets?
If yes, what helped you achieve them? If no, what is the reason for not achieving them?
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__________________________________________________________________________________
__________________________________________________________________________________
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__________________________________________________________________________________

2. In today’s session, which part of the lesson was least clear to you?
__________________________________________________________________________________
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__________________________________________________________________________________
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__________________________________________________________________________________
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FAQs
1. Aside quantitative factor, what are the other factors are considered in deciding when to test
transaction, account balances and disclosures.
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- Aside from size of these items, we are also required to consider the volume of transaction, complexity,
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if it involves judgements, susceptibility to fraud and error, high related party transaction, key
performance indicator and etc.
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