Scoping 1926



  • Okay, here are other questions:%0AWhat constitutes a material misstatement in the financial statements? %0AWhat constitutes materiality for a control activity - in other words, if we’re considering removing a control due to being immaterial, what reasoning should be documented for its removal? Someone mentioned 5% of EBITDA as the going metric, but I have yet to find any hard data on this, nor do I expect to see anything from the SEC or PCAOB on it.%0AThanks.



  • 5% EBIDTA is used as planning materiality for SOX and can be used for determining significant accounts and processes during scoping.%0A As to whether it can also be used for determining whether or not a weakness is material or not. I would like to know too. Especially as I need to consider this over certain areas before we certify 2006.%0A I have not discussed it with our Auditors yet as they are expempt from attestation this year and have a tendancy to interrupt and delay internal investigations by performing their own independently.%0A I find it difficult to believe that this is the only approach that can be used for materiality and would like to think that 5% of net assets could also be used (often used for financial statement materiality within ext audits). Particularly if a large number of assets exist, but EBIDTA is low due to recent acquisitions etc…



  • Folks,%0AI have attached a write-up on materiality that I created recently. It could be useful to you:%0A Materiality in the identification and evaluation of Misstatements arising out of ineffective controls. %0AIntroduction%0AThe quantitative evaluation of misstatements is a matter of professional judgment and should reflect a measure of materiality that is based on the element or elements of the financial statements that, in the SOX Office’s judgment, are expected to affect the judgment of a reasonable person who will rely on our financial statements. %0AWe are determining materiality level for the financial statements as a whole. Determining a materiality level for the financial statements as a whole helps our judgments in identifying and assessing the risks of material misstatements, in planning the nature, timing and extent of our CSA and in a majority of cases (exceptions being SAB-99 qualitative factors), establish a threshold below which identified misstatements are always considered to be immaterial when evaluating those misstatements and their effect on our CSA efforts thereby affecting our external auditors’ report. %0AAs after-tax income from continuing operations is, in most circumstances, the measure of greatest significance to the financial statement users of entities of for-profit entities like we are, we are using after-tax income from continuing operations as a benchmark for materiality determination.%0AWe have compiled a basis of our determination in the attached risk rating.%0AAs this is the first year of our full blown SOX efforts, due to conservatism coupled with the fact of intricacies of our operations as well as more than average turnover in our workforce, we have selected 5 percent of net income from continuing operations to benchmark our planning materiality i.e. materiality level determined for the financial statements as a whole. For AS 2 purposes, any error over the planning materiality would be deemed a material misstatement.%0ATolerable Error%0AWhen assessing the risks of material misstatements and designing and performing CSA efforts to respond to the assessed risks, we allow for the possibility that some misstatements of lesser amounts than the planning materiality benchmarked above, in the aggregate may result in a material misstatement of financial statements. As manifest in the attached risk rating, as per the AICPA recommendations (they recommend 50% to 75% of the planning materiality), we have applied 50% of planning materiality to be our tolerable error. We have also used the tolerable error threshold to identify a majority of our significant accounts. The tolerable error threshold is also very useful for determination of a significant deficiency used in the context of a reportable condition.%0A %0AInconsequential Misstatement/Deficiency%0AAs per AS 2 a misstatement is inconsequential (which means of no significance) if a reasonable person would conclude, after considering the possibility of further undetected misstatements, that the misstatement, either individually or when aggregated with other misstatements would clearly be immaterial to the financial statements. If a reasonable person could not reach such a conclusion regarding a particular misstatement, that misstatement is more than inconsequential. For ease of use, we are using 20% of Tolerable Error as an inconsequential misstatement for the purpose of our evaluation. We would project misstatements over this inconsequential amount, arising out of ineffective controls to accumulate misstatement errors for the purposes of our evaluation of our SOX 404 control framework.%0AEvaluation of deficiencies%0AFor ease of use, we would use revenue as a benchmark to evaluate deficiencies arising out of ineffectiveness of controls at schools. We are using revenue as a benchmark for school, because, at schools our CSA efforts evolve mainly around revenue related controls. This benchmark is strengthened by the fact that income from continuing operations approximates to 10% of revenue as per the attached Revenue Net Income Correlation Worksheet and ISA 320 illustrates the similar correlation for benchmarking materiality levels. Moreover, this benchmark is useful for schools that are not profitable. Therefore, the planning materiality for schools would be 0.5% of revenue and amounts over 0.05% of revenue would be deemed more than inconsequential, for accumulation of misstatement errors related to ineffectiveness of school controls.%0AProjection of Errors for evaluation%0AWe must evaluate whether a particular ineffective control could lead to a reasonably possible or a reasonably probable misstatement. We may weigh the existence of a supplemental control to mitigate this reasonably possible or reasonably probably misstatement. We may test this supplemental control to gather assurance to mitigate risks caused by this ineffective control. Or the original ineffective control could be a prevent control and we have evaluated effective, a detect control that mitigates the same risks posed, mitigated by original prevent control that was deemed ineffective. Or most probably, there is no misstatement impact due to an ineffective control. Nevertheless, this requires an acute professional judgment. If in doubt, you can escalate your skepticism to your managers. %0AAfter we have determined that an ineffective control could indeed lead to a reasonably possible or reasonably probable misstatement, we must project the dollar amount of misstatement error to determine whether the projected misstatement is more than inconsequential to be accumulated in the accumulation spreadsheet. %0AThe best technique to project an error is to extrapolate the population to determine the projected error based on the known samples in error. Please note that we would extrapolate based on a known error to derive a likely error.%0AConclusion%0AAll ineffective controls determined leading to less than inconsequential misstatements should be manifest in the area of risks template and it is implied based on the accumulation spreadsheet, control not evaluated in the spreadsheet are deemed leading to inconsequential misstatements.



  • Thanks for the Guidance. %0A I see you look to Net income at 5% planning materiality - which is essentially 5% of earnings before interest and taxation.%0A The problem with this is - how can it work if your company is in a loss-making situation for the current year/ or their profits are significantly lower than usually expected because they have high expenditure as the result of a new acquisition?%0AIt makes no sense to me to have planning materiality at such a low level if assets are signifcantly greater?



  • Yes, you can either replace the 5% of EBITDA with 5% of owners equity (Net Assets) or 1% of Total Assets



  • And I had indeed made a reference to SAB-99 for qualitative factors mentioned by EMM



  • Thanks Chaava.
    Regards,
    EMM



  • We do have separate scoping levels for our income statement (USD1MM) and our balance sheet (USD5MM). While the balance sheet materiality level is much higher than the income statement, the income statement level generally drives most of our testing as most balance sheet errors translate into income statement errors.



  • I have new question on scoping. If we’re the parent and we have subsidiary. There is a significant account in the subsidiary. Should this be in SOX scope of parent ? Do we need Management of subsidiary to do SOX in their company especially for that account ? Who can help advise me, please.



  • Scoping is a judgment call. If the subsidiary has one account that is significant to your consolidated financial statements, then you should probably identify controls covering off on financial statement assertions for that account in that subsidiary. It is management’s call as to who performs the controls identification and testing, but I would suggest that the parent company be quite involved in the process.



  • I have new question on scoping. If we’re the parent and we have subsidiary. There is a significant account in the subsidiary. Should this be in SOX scope of parent ? Do we need Management of subsidiary to do SOX in their company especially for that account ? Who can help advise me, please.
    It is the parent that needs to be compliant - never the subsidiary.
    Accounts/processes need to be scoped with reference to the materiality and overall coverage of the parent



  • My company completed an acquisition of a company in 11/06 that will cause our revenues to increase by over 50%. Obviously, our 10k for 2006 will not reflect the financial impact of this company, so how should this acquisition be factored into our 2007 scoping process? I’m considering getting the 2006 actuals for this new company and compiling with our 10k numbers as a starting point. Does this seem reasonable? Should forecasted numbers be used when scoping? We’re a non-accelerated filer, so this is new territory for me.%0AMuch thanks in advance for any advice provided. %0AForecast can never be used for Sarbanes Oxley scoping, it has the be actual figures. In your case the actual 2006 figures should be used.



  • My company completed an acquisition of a company in 11/06 that will cause our revenues to increase by over 50%. Obviously, our 10k for 2006 will not reflect the financial impact of this company, so how should this acquisition be factored into our 2007 scoping process? I’m considering getting the 2006 actuals for this new company and compiling with our 10k numbers as a starting point. Does this seem reasonable? Should forecasted numbers be used when scoping? We’re a non-accelerated filer, so this is new territory for me.%0AMuch thanks in advance for any advice provided. %0AForecast can never be used for Sarbanes Oxley scoping, it has the be actual figures. In your case the actual 2006 figures should be used.



  • Forecast can never be used for Sarbanes Oxley scoping, it has the be actual figures. In your case the actual 2006 figures should be used.
    Yes and no. The best indicator of what the current year will look like will come from your forecast. If you anticipate significant changes in the makeup of your business, then you should change your scope of work to reflect that, based on your latest forecast. At the end of the year, you do need to ensure that you had adequate coverage of your FS through SOX controls testing.



  • Forecast can never be used for Sarbanes Oxley scoping, it has the be actual figures. In your case the actual 2006 figures should be used.
    That’s not strictly true, you could stick your figure in the air for scoping purposes if you so desired.
    Although you might have tougher job convincing your auditors that you have sufficient coverage.



  • I think this is where the terms quantitative and qualitative kick in. I would suggest that you would use actual figures to come up with a quantitative measure for your intial cut at scoping. You would then use your forecasting, etc to qualitatively assess the results of your scope to identify any areas that are expected to increase/decrease in activity. This will enable you to refine your scoping accordingly.


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