Source: Arens, Alvin A., Randal J. Elder & Mark S. Beasley. 2014.

Auditing and Assurance

Steps in Applying Materiality
Step
1

Step
2

Set materiality
for the F/S
as a whole
Determine
performace
materiality

Step
3

Estimate total
misstatement
in segment

Step
4

Estimate the
combined
misstatement

Step
5

Planning
extent of tests

Evaluating
results

Compare combined
estimate with
preliminary or
revised judgement
about materiality

Note:
Known Misstatements are those where the auditor can determine the amount of the misstate
in the account.

Likely Misstatement. The first are misstatements that arise from differences between managem
& auditor's judgement about estimates of account balances. The second are projectio
misstatements based on the auditor's test of a sample from a population.
ILLUSTRATION
Estimated Misstatement Amount
Account

Tolerable
Misstatement

Cash
A/R
Inventory

$
$
$

4,000
20,000
36,000

Total Estimated
Misstatement Amount
Preliminary judgement
about materiality

50,000

Known Misstatement
& Direct Projection
$
$
$

2,000
12,000
31,500

45,500

Sampling
Error

Assumption:
In auditing inventory the auditor found $ 3.500 of net overstatement amounts in a sample of $ 5
of the total population of $ 450.000.
The calculation of the direct projection estimate of misstatement is:
Net misstatements in the sample
Total sampled
$
$
Conclusion:

3,500
50,000

Total recorded
population value
$ 450,000

. Auditing and Assurance Services-An Integrated Approach. Fifteenth Edition.Pearson Education

he amount of the misstatements

fferences between management's

The second are projections of
n.

tatement Amount
Sampling
Error

Total

N/A
$ 6,000
$ 15,750

$
$
$

2,000
18,000
47,250

$ 16,800

62,300

amounts in a sample of $ 50.000

Direct Projection estimate

of misstatement
$ 31,500

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