Materiality 1927
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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.
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How long is a piece of string?
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Not certain. Let me read through the proposals from the SEC and PCAOB and get right back to you on that.
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I think the clarification that is needed (I speak for myself her too), is as to what basis of measurement can you prove that a weakness is not material before it suddenly ends up as a material weakness to be on the year-end certification?
If EBIDTA is the only allowable approach, materiality could be very low indeed (esp if profits for the year were below normal).
Should net assets not also be taken into account?
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Net assets, revenue, EBITDA all seem to be relevant contexts in which to evaluate materiality. Is materiality strictly dollars based? Would a low risk control that exceeds any of the aforementioned metrics be considered to represent a potential material weakness based soley on the dollars associated with it?
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Apologies, my answer was truncated for some reason :oops:
Materiality is a very subjective area (hence the how long is a piece of string comment) and professional judgement comes into play, when disclosing material or significant deficiencies I would expect a much negotiation with the auditors.
Materiality as an audit concept evaluates errors in the context of ‘what would mislead the readers of the accounts’ i.e. if revenues are USD10.2 bn or 10.1 bn is unlikely to affect anyones view on the accounts.
Auditors normally look at Total Revenue, EBITDA and Net Assets and come up with a materiality that ‘feels right’. In my experience this tends to weigh more heavily towards revenue than EBITDA.
The standard of what is material can also vary depending on business context (e.g. a deficiency or error that could turn a profit into a loss may be more sensitive that one that just changes the level of profit) and the risk of an error ocurring due to a deficiency may also be relevant.
Note: When I refer to risk I mean the risk of a deficiency resulting in a financial reporting misstatement.
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Denis makes some great points. %0AI would add that materiality can differ from business to business. %0AA large part of this will be based on what you, as a company and your investors target as key indicators of the health and growth of the business. For a start-up company, that may be slanted more towards revenue growth than EPS. For a mature company, that may be slanted more towards EPS. %0AFor a company with thin margins, it may be that proper classification on the income statement is as important as the bottom line - in other words, did you obtain your profit growth through operating better (margins) or through G-and-A reductions. I don’t necessarily want to invest in a company that achieves its annual targets by slicing G-and-A versus operating more efficiently. %0AFor a highly-leveraged company, the most important thing may be EBITDA or managing the balance sheet. A 5% misstatement on the balance sheet of a low-debt company with a billion dollars of assets, while concerning, may not be as material as the same misstatement to a highly-leveraged company.%0AI guess that the correct answer to the question of materiality is 'it depends '.