Sometimes it’s worthwhile learning from significant audit disciplinary cases held by the Financial Reporting Council and in this particular case we are looking at the use of ‘blended’ or ‘average’ materiality as a benchmark. This is especially relevant for all auditors carrying out audits right now.

Using an average of benchmarks, such as

  • Turnover;
  • Profit before tax; or
  • Assets

does not produce an appropriate materiality figure.

The detail of the case is reported here, involving the audit of the Laura Ashley Group for the YE 30 June 2016.

The level set for materiality in this audit, was more than three times the level that the FRC believed was appropriate under the circumstances. Group materiality was calculated by taking an average of:

  • 5% of profit before tax (PBT) and
  • 5% of revenue (later increased to 2%).

Unfortunately, the benchmark chosen was not appropriate. Revenue was chosen, but, as the Financial Reporting Council commented, ‘It would be extremely unusual for an auditor to use revenue as a materiality benchmark for a retailer’. This is because Laura Ashley was a profit-oriented entity, especially a high-volume low-margin business, and therefore revenue wasn’t the best choice of benchmark.

The calculations carried out produced an initial materiality of £3.5m (13.2% of estimated PBT) which was later increased to £4.3m (16.2% of estimated PBT) during the audit.

This error was compounded by the key matters in the auditors’ report then incorrectly stating both the materiality and the way in which it had been calculated, as a percentage of revenue.

Calculation of materiality can sometimes cause an issue in audits, especially when averages are used to find the figure.

Another problem is where materiality is changed during the audit without clear documentation or justification.

One needs to consider which the important figure is for the client and how the different levels interact. So, for instance here, the turnover figure is far too big to be used to calculate materiality, as errors of below materiality would have a big effect on profit (up to 16.2%) which would clearly be material.

Also relevant here is the (still very relevant) December 2017 Financial Reporting Council Audit Quality Thematic Review on Materiality and ISA (Ireland) 320.

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