KnS School of Business Studies

ACCA F8 & CA CAF 9 (Audit & Assurance)

Index of Materiality
Practice Questions

ACCA Questions
S No Attempt Marks Page No.
1 Q.17 (a) March / June 2019 (4 marks) 2
2 Q.3 (a) June 2013 (5 marks) 5
3 Q.2 (b) June 2010 (5 marks) 7

ICAP Questions
1 Q.7 (a) March 2019 (3 marks) 8
2 Q.7 (a) Sept 2017 (2 marks) 9
3 Q.7 March 2016 (7 marks) 10
4 Q.6 (a) Sept 2014 (5 marks) 11

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KnS School of Business Studies
ACCA F8 & CA CAF 9 (Audit & Assurance)

ACCA March / June 2019

Question 17a

(a) Define and explain materiality and performance materiality. (4 marks)

You are an audit supervisor of Daffodil & Co and are planning the audit of Peony Co for the
year ending 31 May 20X9. The company is a food retailer with a large network of stores
across the country and four warehouses. The company has been a client of your firm for
several years and the forecast profit before tax is $28·9m. The audit manager has attended a
planning meeting with the finance director and has provided you with the following notes of
the meeting.

Planning meeting notes

Peony Co has an internal audit (IA) department which undertakes controls testing across the
network of stores. Each store is visited at least once every 18 months. The audit manager has
discussed with the finance director that the external audit team may rely on the controls
testing which is undertaken by IA.

During the meeting, the finance director provided some forecast financial information.
Revenue for the year is expected to increase by 3% as compared to 20X8; the gross margin is
expected to increase from 56% to 60%; and the operating margin is predicted to decrease from
21% to 18%.

Peony Co values inventory in line with industry practice, which is to use selling price less
average profit margin. The directors consider this to be a close approximation to cost.

The company does not undertake a full year-end inventory count and instead undertakes
monthly perpetual inventory counts, each of which covers one-twelfth of all lines in stores
and the warehouses. As part of the interim audit which was completed in January, an audit
junior attended a perpetual inventory count at one of the warehouses and noted that there
were a large number of exceptions where the inventory records showed a higher quantity than
the physical inventory which was present in the warehouse. When discussing these exceptions
with the financial controller, the audit junior was informed that this had been a recurring
issue.

During the year, IA performed a review of the non-current assets physically present in around
one-third of the company’s stores. A number of assets which had not been fully depreciated
were identified as obsolete by this review.

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The company launched a significant TV advertising campaign in January 20X9 in order to
increase revenue. The directors have indicated that at the year end a current asset of $0·7m
will be recognised, as they believe that the advertisements will help to boost future sales in the
next 12 months. The last advertisement will be shown on TV in early May 20X9.

Peony Co decided to outsource its payroll function to an external service organisation. This
service organisation handles all elements of the payroll cycle and sends monthly reports to
Peony Co which detail wages and salaries and statutory obligations. Peony Co maintained its
own payroll records until 31 December 20X8, at which point the records were transferred to
the service organisation.

Peony Co is planning to expand the company by opening three new stores during July 20X9
and in order to finance this, in March 20X9 the company obtained a $3m bank loan. This is
repayable in arrears over five years in quarterly installments. In preparation for the expansion,
the company is looking to streamline operations in the warehouses and is planning to make
approximately 60 employees redundant after the year end. No decision has been made as to
when this will be announced, but it is likely to be in May 20X9.

Answer
a. Materiality and performance materiality
Materiality and performance materiality are dealt with under ISA 320 Materiality in Planning
and Performing an Audit. Auditors need to establish the materiality level for the financial
statements as a whole, as well as assess performance materiality levels, which are lower than
the overall materiality for the financial statements as a whole.

Materiality
Materiality is defined in ISA 320 as follows: ‘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
statements.

If the financial statements include a material misstatement, then they will not present fairly
(give a true and fair view) the position, performance and cash flows of the entity.

A misstatement may be considered material due to its size (quantitative) and/or due to its
nature (qualitative) or a combination of both. The quantitative nature of a misstatement refers
to its relative size. A misstatement which is material due to its nature refers to an amount
which might be low in value but due to its prominence and relevance could influence the
user’s decision, for example, directors’ transactions.

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As per ISA 320, materiality is often calculated using benchmarks such as 5% of profit before
tax or 1% of total revenue or total assets. These values are useful as a starting point for
assessing materiality, however, the assessment of what is material is ultimately a matter of the
auditor’s professional judgement. It is affected by the auditor’s perception of the financial
information, the needs of the users of the financial statements and the perceived level of risk;
the higher the risk, the lower the level of overall materiality.

In assessing materiality, the auditor must consider that a number of errors each with a low
value may, when aggregated, amount to a material misstatement.

Performance materiality

Performance materiality is defined in ISA 320 as follows: ‘The amount set by the auditor at
less than materiality for the financial statements 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 statements as a whole.

Hence performance materiality is set at a level lower than overall materiality for the financial
statements as a whole. It is used for testing individual transactions, account balances and
disclosures. The aim of performance materiality is to reduce the risk that the total of all of the
errors in balances, transactions and disclosures exceeds overall materiality.

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KnS School of Business Studies
ACCA F8 & CA CAF 9 (Audit & Assurance)

ACCA June 2013

Question 3a

(a) Explain the concepts of materiality and performance materiality in accordance with
ISA 320 Materiality in Planning and Performing an Audit. (5 marks)

Answer

a. Materiality and performance materiality

Materiality and performance materiality are dealt with under ISA 320 Materiality in Planning
and Performing an Audit. Auditors need to establish the materiality level for the financial
statements as a whole, as well as assess performance materiality levels, which are lower than
the overall materiality.

Materiality is defined in ISA 320 as follows:

‘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 statements.’

In assessing the level of materiality, there are a number of areas that should be considered.
First the auditor must consider both the amount (quantity) and the nature (quality) of any
misstatements, or a combination of both. The quantity of the misstatement refers to the
relative size of it and the quality refers to an amount that might be low in value but due to its
prominence could influence the user’s decision, for example, directors’ transactions.

As per ISA 320, materiality is often calculated using benchmarks such as 5% of profit before
tax or 1% of total revenue or total expenses. These values are useful as a starting point for
assessing materiality.

The assessment of what is material is ultimately a matter of the auditor’s professional

judgement, and it is affected by the auditor’s perception of the financial information needs of
users of the financial statements and the perceived level of risk; the higher the risk, the lower
the level of overall materiality.

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ACCA F8 & CA CAF 9 (Audit & Assurance)
In assessing materiality, the auditor must consider that a number of errors each with a low
value may, when aggregated, amount to a material misstatement.

In calculating materiality, the auditor should also set the performance materiality level.
Performance materiality is normally set at a level lower than overall materiality. It is used for
testing individual transactions, account balances and disclosures. The aim of performance
materiality is to reduce the risk that the total of errors in balances, transactions and disclosures
does not in total exceed overall materiality.

Tutorial note: Award marks for ISA 320 definition of performance materiality below:

‘Performance materiality means the amount or amounts set by the auditor at less than
materiality for the financial statements 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 statements 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.’

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ACCA F8 & CA CAF 9 (Audit & Assurance)

ACCA June 2010

Question 2b
(b) ISA 320 Materiality in Planning and Performing an Audit provides guidance on the concept
of materiality in planning and performing an audit.

Required:

Define materiality and determine how the level of materiality is assessed. (5 marks)

Answer
(b) Materiality is defined as follows:

‘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 statements.’

In assessing the level of materiality there are a number of areas that should be considered.
Firstly the auditor must consider both the amount (quantity) and the nature (quality) of any
misstatements, or a combination of both. The quantity of the misstatement refers to the
relative size of it and the quality refers to an amount that might be low in value but due to its
prominence could influence the user’s decision, for example, directors’ transactions.

In assessing materiality the auditor must consider that a number of errors each with a low
value may when aggregated amount to a material misstatement.

The assessment of what is material is ultimately a matter of the auditors’ professional

judgement, and it is affected by the auditor’s perception of the financial information needs of
users of the financial statements.

In calculating materiality the auditor should also consider setting the performance materiality
level. This is the amount set by the auditor, it is below materiality, and is used for the
particular classes of transactions, account balances and disclosures.

As per ISA 320 materiality is often calculated using benchmarks such as 5% of profit before
tax or 1% of gross revenue. These values are useful as a starting point for assessing materiality.
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KnS School of Business Studies
ACCA F8 & CA CAF 9 (Audit & Assurance)

ICAP QUESTIONS

ICAP March 2019

Question 7a

(a) Discuss the term 'performance materiality' and the purpose for which it is used (03)

Answer
Performance materiality means the amount or amounts set by the auditor at less than
materiality for the financial statements as a whole or at less than the materiality level for
particular classes of transactions, account balance or disclosures.

Performance materiality is set to reduce to an appropriately low level the probability that the
aggregate of uncorrected and undetected misstatements in the financial statements or in
classes of transactions, account balance or disclosures exceeds the materiality as a whole.

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ACCA F8 & CA CAF 9 (Audit & Assurance)

ICAP Sept 2017

Question 7 a
(a) Apart from profit before tax, list any four benchmarks which can be used to determine
the materiality at the financial statement level. (02)

Answer
The following can be the benchmark for determining materiality:

• Gross profit
• Total expenses
• Total equity
• Total assets
• Total revenue

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ICAP March 2016

Question 7

Determination of materiality level requires professional judgement on the part of the

auditor.

a. Briefly describe the importance of materiality in the following stages of audit:

i. Planning stage (01)

ii. Reporting stage (02)

b. What aspects of materiality should be documented by an auditor in the working

papers? (04)

Answer
a.
i. Planning stage – The concept of materiality is used in determining the nature,
timing and extent of further audit procedures;

ii. Reporting stage – The materiality concept is used in evaluating the effect of
uncorrected misstatements, if any, on the financial statements and in forming the
opinion in the auditor's report.

b. The auditor shall document the following aspects of materiality:

i. Materiality for the financial statements as a whole;

ii. Performance materiality;
iii. Basis of computing materiality; and
iv. Any revision of (i) to (ii) as the audit progresses.

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ICAP Sept 2014

Question 6 c

You are the training manager in a firm of chartered accountants. Prepare brief presentation
for newly inducted trainees, on the following:

c. Materiality and Performance Materiality. (05)

Answer
c. Materiality:

Information is material if its omission or misstatement could influence the economic decisions
of users taken on the basis of financial statements. The auditor keeping in view the concept of
materiality gives his opinion i.e. whether the financial statements present fairly in all material
respects the financial position and performance of the entity.

Performance Materiality:

Performance materiality means the amount or amounts set by the auditor at less than
materiality for the financial statements 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 statements 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.

Performance materiality recognizes the fact that errors/omissions detected in a particular area
may not breach the overall materiality level but when all the errors/omissions in all the areas
is combined or added together, the overall materiality could be breached.

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ACCA F8 & CA CAF 9 (Audit & Assurance)

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