FRC issues report on auditor's materiality judgements
News types: Publications
Published: 16 December 2013
PN 109
The Financial Reporting Council (FRC) has today published the report of its first Audit Quality Thematic Review (PDF) into the auditor’s consideration and application of materiality. Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.
The report identifies a requirement for greater focus by auditors on the needs and expectations of users in setting and revising overall materiality levels and for audit committees to seek to better understand the related judgements made by auditors. It also makes a number of recommendations to audit committees and encourages them to discuss with their auditors the basis for the materiality levels set including, in particular, how these reflect the needs and expectations of users of the entity’s financial statements.
Materiality is an area of particular interest to investors given its potential impact on the scope of an audit and the extent of the audit work performed. Audit committees play a highly important role in safeguarding the quality of audit and should actively engage with their auditors in relation to the determination and application of materiality.
The recent revision of ISA (UK and Ireland) 700 requires auditors to report how they applied the concept of materiality in performing the audit and how this affected the scope of their audit. This will enable investors and other users of financial statements to engage directly with audit committees in relation to this area.
Paul George, Executive Director, Conduct said:
The Financial Reporting Council (FRC) has today published the report of its first Audit Quality Thematic Review (PDF) into the auditor’s consideration and application of materiality. Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.
The report identifies a requirement for greater focus by auditors on the needs and expectations of users in setting and revising overall materiality levels and for audit committees to seek to better understand the related judgements made by auditors. It also makes a number of recommendations to audit committees and encourages them to discuss with their auditors the basis for the materiality levels set including, in particular, how these reflect the needs and expectations of users of the entity’s financial statements.
Materiality is an area of particular interest to investors given its potential impact on the scope of an audit and the extent of the audit work performed. Audit committees play a highly important role in safeguarding the quality of audit and should actively engage with their auditors in relation to the determination and application of materiality.
The recent revision of ISA (UK and Ireland) 700 requires auditors to report how they applied the concept of materiality in performing the audit and how this affected the scope of their audit. This will enable investors and other users of financial statements to engage directly with audit committees in relation to this area.
Paul George, Executive Director, Conduct said:
"Thematic reviews enable us to probe deeper into aspects of auditing not normally considered in detail during routine inspections. They allow us to make comparisons between firms with a view to identifying both good practice and areas of common weakness. This report should promote a better understanding of current practice at the largest firms and how materiality decisions affect the scope and extent of auditors’ work. Our findings assist the development of good practice within firms and should help Audit Committees in discharging their responsibilities.”
Key messages
- Qualitative factors relating to the needs and expectations of users of an entity’s financial statements should be the overriding consideration for auditors in determining the overall materiality level.
- Auditors should ensure that where materiality benchmarks are adjusted for ‘one-off’ items, these adjustments are appropriate in the circumstances. Firms should ensure that their guidance assists audit teams in making these judgments.
- Auditors should demonstrate the consideration of risk in setting performance materiality and avoid, as a default, simply setting this at the highest level allowed under their firm’s guidance.
- Auditors should improve the quality and accuracy of their reporting of materiality levels to Audit Committees and ensure that all uncorrected misstatements above the reporting threshold agreed are collated and reported.
- Auditors should ensure that materiality is appropriately addressed when planning analytical procedures.
- Audit firms should review their internal guidance in the light of the areas requiring improvement identified in the report, including in particular how the needs and expectations of users of financial statements are assessed and taken into account in determining materiality levels.
Notes to editors:
- The FRC is responsible for promoting high quality corporate governance and reporting to foster investment. We set the UK Corporate Governance and Stewardship Codes as well as UK standards for accounting, auditing and actuarial work. We represent UK interests in international standard-setting. We also monitor and take action to promote the quality of corporate reporting and auditing. We operate independent disciplinary arrangements for accountants and actuaries; and oversee the regulatory activities of the accountancy and actuarial professional bodies.
- Thematic reviews supplement the FRC’s annual programme of audit inspections of individual firms. For a thematic review the AQR examines firms’ policies and procedures in respect of a specific aspect of auditing, and their practical application, allowing the AQR to focus in greater depth than is generally possible in their annual inspections. The FRC will monitor how auditors are applying the new reporting requirements in practice during 2014 and consider the implications for other initiatives designed to enhance the quality and value of auditing and the effectiveness of auditors’ communications with stakeholders.
- The AQR visited the six largest audit firms (BDO LLP, Deloitte LLP, Ernst & Young LLP, Grant Thornton UK LLP, KPMG LLP and KPMG Audit plc and PricewaterhouseCoopers LLP) to review their audit methodology and guidance in respect of materiality. The AQR also reviewed relevant aspects of the audit procedures performed for 26 entities in the retail, construction, real estate, industrial products, support services, banking, software and mining industries. These reviews related to audits of financial statements for financial year ends between March 2012 and March 2013. At least one entity which was near break-even or was loss-making was selected at each firm in order to assess how auditors used their judgment in determining materiality.