Concept of Materiality, PM and CTT?
Materiality is the threshold above which misstatements or omissions could influence the economic decisions of users.
It is important to determine materiality for auditors to focus their time and efforts on the most significant areas of the financial statements.
And prioritize their work on areas that are most likely to contain misstatements that could influence the economic decisions of users.
Now, there are two other concepts which are equally important as that of Materiality which are:
Performance Materiality (PM) and
Clearly Trivial Threshold (CTT).
Performance Materiality (PM) is a lower threshold set to reduce the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality. It is important to provide a buffer to ensure that the total misstatements do not exceed overall materiality.
Clearly Trivial Threshold (CTT) is the threshold below which misstatements are considered too small to be of concern and are not accumulated by the auditor. It is important in order to disregard misstatements that are clearly inconsequential to the financial statements.
1Let’s take an example to understand these concepts better.
Company: Bamboo Inc.
Annual Revenue: $100 million
Net Income: $5 million
Materiality:
The auditor determines that 5% of net income is an appropriate benchmark for materiality.
Materiality = 5% of $5 million = $250,000
Any misstatement or omission in the financial statements exceeding $250,000 is considered material and could influence the decisions of users.
Performance Materiality:
The auditor sets performance materiality at 75% of overall materiality.
Performance Materiality = 75% of $250,000 = $187,500
The auditor uses $187,500 as the threshold for planning and performing audit procedures on individual account balances, classes of transactions, or disclosures.
This buffer helps ensure that the total of uncorrected and undetected misstatements does not exceed the overall materiality of $250,000.
Clearly Trivial Threshold:
The auditor sets the clearly trivial threshold at 5% of overall materiality.
Clearly Trivial Threshold = 5% of $250,000 = $12,500
Any individual misstatement below $12,500 is considered clearly trivial.
These misstatements are not accumulated or reported because they are deemed inconsequential to the financial statements.
Summary of Thresholds:
Materiality: $250,000
Performance Materiality: $187,500
Clearly Trivial Threshold: $12,500
Please note that the above example does not explain how to determine materiality; it's meant to simplify the concept for easier understanding. I'll dive into the details of determining materiality in my next newsletter.