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The Sarbanes Oxley Act :: View topic - Materiality calculation - comments appreciated!
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Materiality calculation - comments appreciated!

 
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Chris
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Joined: Aug 10, 2004
Posts: 19
Location: Calgary Canada

PostPosted: Wed Apr 13, 2005 12:31 pm    Post subject: Materiality calculation - comments appreciated! Reply with quote

G'day all!
Here's the issue. We need to determine what our threshold for Significant Deficiency is. Actually, we've defined it but our auditors are suggesting it's too high... but not providing any rationalle for their reasoning.

Anyway, here is what we've calculated. Any comments on any of the numbers will be appreciated.
Please note, for the purposes of this post, I am not considering the "qualitative" factors that could result in a Significant Deficiency or Material Weakenss. We are, of course, considering these in our project!

Company is forecast to make 1.4billion after tax earnings. Stable company so let's assume that is a reasonable figure to work from.

Using the "rule of thumb" we've identified our materiality as 10% of after tax income thus $140 million. To take into account the potential for unidentified errors we'll reduce the 140 and take only 70% of materiality to arrive at 98 million but for ease we'll use $100 million as our materiality amount.
Therefore any error that could result in a misstatement of =>100million will automatically be considered a material weakness. This is also essentially the same as what our auditors have defined as financial statement materiality.

Now we need to determine what a significant account is and what would constitute a Significant Deficiency. Using the "Framework for Evaluating Control Exceptions and Deficiencies" (pg 15) we find that misstatements => 20% of overall annual financial statement materiality (the $100MM calculated above) are defined as "more than inconsequential" and therefore are classed as a Significant Deficiency.
20% x 100mm = $20mm

We have then taken this Significant Deficiency threshold of $20mm and used that as our scoping number. Any account (with a balance of less than $20mm or that does not have the potential to cause an error of $20mm or more is determined to be immaterial.

In summary:
$1,400mm after tax earnings
$100mm materiality level / material weakness threshold
$20mm significant account / significant deficiency threshold

Our auditors are suggesting the $20mm be reduced to $5mm. They do agree with the $100mm materiality level.

Any comments??? Anyone willing to share their numbers???
All thoughts and comments appreciated.

Thanks
Chris.
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IrquiM
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PostPosted: Thu Apr 14, 2005 1:32 am    Post subject: Reply with quote

My company operates with a 1.5mm significant account

Our net operating value is ~1,000mm.
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plaire1
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PostPosted: Mon May 16, 2005 1:18 pm    Post subject: Reply with quote

We were told it should be in the few millions, seperate or aggregated together. External Audit will not give you a specific number as there are varied factors that come into play... It's an analytical dream area...

Seperate 1 - 2 hundred thousand, depending on the exception, risk.. low med or high, then play in the Management Response the Potential Magnitude: Impact is Low, Likelihood is Low. Magnitude of the impact is minimal. Then there is the Complementary or Redundant Controls:
Compensating Controls, then there is the Conclusion: "The control is ineffective, however compensating controls will prevent any impact to financial statements" after all that....... BUT then you get into aggregating all the exceptions (or deficient controls) and play the game again....

aggregated we play by a few million, seperate a few hundred thousand....You can also throw back to external auditiors the legal mumbo jumbo they like
"Considering the overall compensating controls (described below) and the De minimis magnitude of the potential error as described above, further mitigating controls provide additional assurance that this control deficiency results in no more than an De minimis impact to the financial statements. The following control strongly mitigates any potential error"..... enjoy
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Denis
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Location: London, UK

PostPosted: Tue May 17, 2005 3:42 am    Post subject: Re: Materiality calculation - comments appreciated! Reply with quote

Chris wrote:

In summary:
$1,400mm after tax earnings
$100mm materiality level / material weakness threshold
$20mm significant account / significant deficiency threshold

Our auditors are suggesting the $20mm be reduced to $5mm. They do agree with the $100mm materiality level.



I would expect that the threshold for a significant weakness to be 10% of the material threshold - so in your case $10 million.

I agree with your rationale in getting to $100 million for material weakness.
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LS
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PostPosted: Wed May 18, 2005 8:25 am    Post subject: Reply with quote

We have been using 20% of materiality to quantify "inconsequential." This was derived from "A Framework for Evaluating Control Exceptions and Deficiencies" Version 3, December 20, 2004 (see Terminology section). I thought this was pretty straightforward based on reading the framework, so I'm surprised to see this becoming an issue. What is the basis for your auditors refuting the 20%?
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lekatis
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Joined: Feb 15, 2005
Posts: 302
Location: USA

PostPosted: Thu May 19, 2005 11:37 am    Post subject: Reply with quote

Just a comment:

The Framework for Evaluating Control Exceptions and Deficiencies
was developed by representatives of the following nine firms:

BDO Seidman LLP, Crowe Chizek and Company LLC, Deloitte & Touche LLP, Ernst & Young LLP, Grant Thornton LLP, Harbinger PLC, KPMG LLP, McGladrey & Pullen LLP, PricewaterhouseCoopers LLP.

Must be read in conjunction with Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction With an Audit of Financial Statements.

Download:
aicpa.org/cpcaf/download/Framework%20--%20Version%203.pdf

At the end of this document (pages 19-22) there are 4 excellent charts.
Pages 5-18:Explanations in order to understand the charts

HIGHLY RECOMMENDED
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