PART 1 Materiality

W&S Partners commenced planning the Cloud 9 audit by gaining an understanding of the clients

structure and its business environment. A major task is to consider the concept of materiality as

it applies to the client. The auditor will design procedures in order to identify and correct errors or

irregularities that would have a material effect on the financial report and affect the decision making

of the users of the financial report. Materiality is used in determining audit procedures and sample

selections, and evaluating differences from client records to audit results. It is the maximum amount

of misstatement, individually or in aggregate, that can be accepted in the financial report. In selecting

the base figure to be used to calculate materiality, an auditor should consider the key drivers of the

business. They should ask, What are the end users (that is, shareholders, banks etc.) of the accounts

going to be looking at? For example, will shareholders be interested in profit figures that can be used

to pay dividends and increase share price?

W&S Partners audit methodology dictates that one planning materiality (PM) amount is to

be used for the financial report as a whole (that is, rather than separate PMs for the income

statement and the balance sheet). Further, only one basis should be selected a blended

approach or average should not be used. The basis selected is the one determined to be the key

driver of the business.

W&S Partners use the following percentages as starting points for the various bases:

Base Threshold (%)

Profit before tax 5

Turnover 2

Gross profit 0.5

Total assets 1

Equity

These starting points can be increased or decreased by taking into account qualitative client factors,

which could be:

t the nature of the clients business and industry (for example, rapidly changing, either through growth

or downsizing, or an unstable environment)

t if the client is a listed entity (or subsidiary of) subject to regulations

t the knowledge of or high risk of fraud.

Typically, profit before tax is used; however, it cannot be used if reporting a loss for the year, if

profitability is impacted significantly by one off adjustments or transactions, or if the users of the

financial report are not basing their investment (or other) decisions on a profit basis.

When calculating PM based on interim figures, it may be necessary to annualise the results. This

allows the auditor to plan the audit properly based on an approximate projected year-end balance.

Then, at year-end, the figure is adjusted, if necessary, to reflect the actual results.

Required

Using the 30 September 2016 trial balance (in the appendix to this text), calculate planning materiality

and include the justification for the basis that you have used for your calculation.

When you are answering the question, you should refer to the information presented for Cloud 9

in the appendix to this text and in the current and earlier chapters. You should also consider your

answers to the case study questions in earlier chapters.