Audit Q&A: Clarified ISA issues

With the audit season kicking off for December 2011 year-ends, Steve Collings looks at some of the more frequently asked questions relating to the clarified International Standards on Auditing (ISAs)

Q. I’ve heard that the use of ‘analytical procedures’ are mandatory in external audits, but I’m struggling to understand what they actually are.

A. ISA 520 (UK and Ireland), Analytical Procedures defines analytical procedures as ‘evaluations of financial information made by a study of plausible relationships        among both financial and non-financial data.’ Essentially what you’re looking at are fluctuations and relationships which are not considered to be consistent with other information in the financial statements or which deviate from predicted amounts. For example, if the directors tell you that gross profit margins have remained            consistent with the previous year, but the variance analysis tells you that they have, in fact, significantly fallen, the auditor would need to design procedures to identify the inconsistency between the directors’ assertion and the financial statements. Q. Are there are any other methods of calculating materiality other than the usual average of 1% of turnover, 2% of gross assets and 5% of pre-tax profit?

A. ISA 320 (UK & Ireland), Audit materiality does not specify the manner in which materiality levels are calculated. ISA 320 defines materiality at paragraph three as follows:      

‘Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.’

The method of calculating materiality using turnover, gross assets and pre-tax profit has become an established practice over time. What is important is the judgement  of the auditor and the nature of the amount concerned. For example a £100 overstated prepayment may be immaterial to a £100 million turnover company, but the transfer of £100 worth of shares by the director to, say, a holding company would be material in nature. 

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates Ltd and the author of ‘The Interpretation and Application of International Standards on Auditing’ (Wiley March 2011). He is also the author of ‘The AccountingWEB Guide to IFRS’ (Sift Media May 2011) and IFRS For Dummies (Wiley April 2012). He was also named Accounting Technician of the Year in the 2011 British Accountancy Awards.

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