Relationship between materiality and audit
As I was preparing for the next Advanced Audit and Assurance webinar, one of my students asked me about materiality and the amount of audit work that will be performed. This concept often causes a lot of confusion for CPA candidates so I thought a short blog explaining the concept could help.
It is difficult for candidates to understand why an increase in materiality will cause a decrease in the amount of audit work performed and vice versa. So here is an explanation that I hope will clarify this issue.
Materiality – How it works
When materiality is set at a lower amount, then more things would be considered ‘material’ and thus more things would be scoped in for testing. However, if materiality is set at a larger amount, then there are more items that would be scoped out of the sample selection because it would fall below the higher materiality amount. Thus, the sample would be smaller.
Consider the following example:
Entity A has a debtor’s balance of $100. This balance comprises the following invoices:
– 5 invoices for $2 each
– 4 invoices for $5 each
– 5 invoices for $10 each
– 1 invoice for $20
The total of all these invoices is $100.
Testing at $5
Now if the auditor was testing this debtor and the materiality was set at $5, then the sample size would likely be 10 invoices.
4 invoices of $5 each + 5 invoices of $10 each + 1 invoice of $20 = 10 invoices
All these invoices contain amounts that are equal to or greater than the materiality set.
Testing at $10
But if I increase materiality level to $10….then my sample size will decrease to 6 invoices.
5 invoices of $10 + 1 invoice of $20 = 6 invoices.
The invoices below $10 are not likely to be selected because they are less than the materiality set.
Can you see how the increase in the level of materiality reduced the sample size? In doing so, decreases the audit work that will be performed.
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