Learning Outcomes
After reading this article, you will be able to define and calculate planning materiality and performance materiality, explain their role in shaping an audit strategy, and outline the audit documentation required by ISA 230. You will also be able to identify the format, content, and retention requirements of working papers and audit files, ensuring compliance and audit quality for the ACCA AA exam.
ACCA Audit and Assurance (AA) Syllabus
For ACCA Audit and Assurance (AA), you are required to understand how to apply materiality and performance materiality rules, develop an audit strategy, and meet planning documentation requirements under ISAs. Focus your revision on:
- The definition and calculation of materiality and performance materiality for planning and performing audits.
- The use of materiality in identifying significant risk areas and planning audit responses.
- The contents and format of audit strategy and audit plan documentation (ISA 300/ISA 230).
- The requirements for preparation, assembly, and retention of working papers.
- The form, content, and ownership of audit files and documentation, including security and confidentiality.
- Procedures to ensure audit evidence is traceable and reviews are properly documented.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- Define materiality in the context of planning an audit engagement, and give two benchmarks commonly used to calculate it.
- Explain the purpose of an audit strategy. How does it relate to the audit plan?
- List three key elements that must be included in audit working papers according to ISA 230.
- What is the minimum retention period for audit working papers, and who owns them?
Introduction
Appropriate use of materiality is a core part of effective audit planning. The auditor must identify an acceptable level of misstatement (materiality) that could influence economic decisions made from the financial statements. Materiality shapes the audit strategy and the detailed audit plan. Documentation, meanwhile, is the backbone of audit quality—it enables supervision, review, and demonstrates that the engagement followed applicable standards.
Key Term: Materiality
The magnitude of misstatements (including omissions) that could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements.
Determining Materiality in Audit Planning
The role of planning materiality
Materiality is set at the planning stage to focus audit efforts on items or areas where misstatements would affect users’ decisions. Materiality may be revised as the audit progresses, but the initial figure is essential—it underpins risk assessment, sample sizes, and the evaluation of errors identified during the audit.
Quantitative and qualitative factors
Materiality is not based purely on size, but on both the amount (quantitative) and the nature (qualitative) of an item.
Key Term: Performance Materiality
An amount set by the auditor at less than overall materiality for the financial statements as a whole, to reduce to an appropriately low risk that the sum of undetected and uncorrected misstatements exceeds materiality.
Benchmarks and calculation
Auditors often use standard benchmarks based on financial statement figures. These may include:
- ½% to 1% of revenue
- 1% to 2% of total assets
- 5% to 10% of profit before tax
The lower end of the range should be used for new audits or where the risk of misstatement is higher.
Materiality by nature
Certain items may be material by nature even if small in absolute value—such as director transactions, breaches of regulatory requirements, or instances that turn a reported profit into a loss.
Adjusting materiality during the audit
Materiality must be reassessed if significant changes are identified (e.g., actual figures differ markedly from the initial draft, or serious new risks arise).
Worked Example 1.1
A company shows profit before tax of $2m, revenue of $55m, and total assets of $38m. What is an appropriate planning materiality?
Answer:
5% of profit before tax = $100,000
1% of total assets = $380,000
½% of revenue = $275,000
A suitable planning materiality would be the lowest, say $100,000, to be prudent, but circumstances (such as recurring audit, low risk) may allow use of a higher figure as long as justified.
Performance Materiality and Aggregated Misstatements
Performance materiality is set below overall materiality to ensure that undetected and uncorrected misstatements, taken together, do not exceed overall materiality. This accounts for sampling error and the possibility of multiple small errors aggregating to a material amount.
Worked Example 1.2
If overall materiality is $100,000, and the risk of multiple misstatements is higher due to weaker controls, what might performance materiality be set at?
Answer:
It may be set at $75,000 or lower, reflecting the increased risk that many errors could aggregate to a material amount.
Materiality's Impact on Audit Strategy & Plan
Materiality judgments drive the audit strategy by identifying the risk areas and focusing resources on those balances and transactions most likely to contain material misstatements.
- Higher risk, or items material by nature, may prompt expanded procedures.
- Items well below planning materiality—unless qualitatively significant—may receive less attention.
- Audit procedures are tailored: control testing, sampling sizes, and the extent of substantive work are all influenced by the level of materiality and performance materiality.
Audit strategy and audit plan distinction
Key Term: Audit Strategy
A document that records the scope, timing, and direction of the audit and allocates resources to key areas.Key Term: Audit Plan
A detailed description of the nature, timing, and extent of audit procedures, including who performs them, sample sizes, and when they will be carried out.
Worked Example 1.3
An entity experiences falling gross margins and increasing loan balances. How should this affect the audit strategy and plan?
Answer:
The audit strategy should direct more resources to revenue recognition and debt covenants—possibly lowering materiality for these areas. The audit plan would specify increased substantive testing of margin calculations and checks on loan classification and disclosures.
Revision Tip
Always recalculate materiality using the most up-to-date figures before concluding the audit. Document reasons for any significant changes.
Audit Documentation Requirements (ISA 230)
The importance of documentation
Audit documentation is the record supporting the auditor’s report. It provides:
- Evidence of compliance with ISAs and legal requirements
- A basis for review and supervision
- A record for future audits
ISA 230 requires that documentation be sufficient to enable an experienced auditor, with no prior connection, to understand what work was performed, by whom, results obtained, and conclusions reached.
Key Term: Audit Working Papers
The records prepared or obtained and retained by auditors in connection with the performance of the audit.
Form, Content, and Ownership
Documentation may be electronic or paper-based. It should include:
- Client name and period;
- Name and date of preparer and reviewer;
- Objective and description of work performed;
- Results identified and conclusions drawn;
- Cross-references to supporting papers.
Ownership: Audit working papers and files belong to the auditor, not the client.
Assembly and retention
Final assembly of the audit file must be made soon after the report date—usually within 60 days. Working papers must be retained for at least five years from the auditor’s report date (or longer as required by law/regulation).
Security and confidentiality
Working papers must be kept secure and confidential and protected from unauthorised access, loss, or tampering. This applies equally to electronic and paper files.
Types of working papers
- Permanent file: background information about the client kept for future audits (e.g., articles of association, lease agreements, system documentation).
- Current file: documents relating to the specific year’s audit (e.g., lead schedules, trial balance, risk assessment, planning memo, substantive tests, adjustments, reporting).
Exam Warning
Failing to document sample selection, procedures performed, or not stating conclusions may result in loss of review evidence and could lead to regulatory or disciplinary action.
Summary
Materiality drives every phase of audit planning and execution, determining which balances and transactions may affect users' decisions and require audit attention. Performance materiality provides a further buffer against aggregation risk. Documentation, required by ISA 230, is critical to demonstrate compliance, facilitate review, and safeguard audit quality. Correctly completed and retained working papers evidence your entire approach from planning through reporting.
Key Point Checklist
This article has covered the following key knowledge points:
- Define materiality and performance materiality; identify how they are calculated and applied.
- Explain the impact of materiality on the audit strategy and audit plan.
- Outline required contents and format of audit documentation under ISA 230.
- State the purpose, ownership, and retention requirements of audit working papers and files.
- Describe minimum security and confidentiality procedures for audit documentation.
Key Terms and Concepts
- Materiality
- Performance Materiality
- Audit Strategy
- Audit Plan
- Audit Working Papers