Academic journal article Journal of Accountancy

Component Materiality for Group Audits

Academic journal article Journal of Accountancy

Component Materiality for Group Audits

Article excerpt


* Regulator inspections and firms' quality reviews have revealed a variety of methods used by group engagement partners in determining component materiality and have identified potentially troubling matters with some of the current approaches.

* International Auditing Standard (IAS) no. 600, Special Considerations--Audits of Group Financial Statements (Including the Work of Component Auditors), defines a continuum of materiality amounts that conceivably could be allocated to components. A reasonable, practical approach is allocating overall materiality to components while avoiding the extremes of the continuum.

* Benchmark multiples are suggested as reasonable upper bounds for group engagement partners to consider when evaluating the appropriateness of aggregate component materiality and component materiality allocations. These multiples are based on a simple probabilistic model that takes into account the number of components to which overall materiality is to be allocated and audit risk at the component and group levels.

Determining overall group materiality and materiality levels for individual components is becoming more of a hot-button issue as the number and complexity of large and international group audits increases. Auditing standards and other professional materials offer little practical guidance on the topic.

Internal and peer reviews and regulatory inspections have revealed a variety of approaches in this area. In some instances, reviews have discovered potentially troubling practices. Our conversations with regulators and practitioners indicate an intense and growing interest in the development of conceptually sound guidance. This article outlines a practical approach that group engagement partners can consider in establishing or evaluating component materiality.


A group audit is performed on an entity with multiple locations or components, such as subsidiaries, with separately audited financial information included in consolidated or group financial statements. To properly plan the nature and extent of audit procedures for the group audit, the group engagement partner, who is the lead auditor for the consolidated entity, must determine group overall materiality and establish or approve appropriate materiality levels for the individual components. The component materiality level helps guide the component auditors in planning and performing audit procedures to achieve the desired level of audit risk at each component such that the group auditor achieves the desired level of group overall audit risk on the consolidated financial statements.

U.S. auditing standards (AU section 312 and PCAOB's Auditing Standard no. 5, paragraphs B10-B16 of Appendix B) provide a list of factors to consider in determining the extent of testing on a multicomponent audit. However, these standards don't provide specific practical guidance on establishing component-level planning materiality, one of the principal factors used to determine the extent of testing.

The International Auditing and Assurance Standards Board (IAASB) recently released a revised and redrafted International Standard on Auditing (ISA) 600, Special Considerations--Audits of Group Financial Statements (Including the Work of Component Auditors), to provide additional guidance to group engagement partners. Paragraphs 21-23 and A42-A46 of ISA 600 provide guidance to help inform group engagement partner materiality decisions. Paragraph A43 provides the following guidelines regarding component materiality:

1. To reduce the risk that the aggregate of detected and undetected misstatements in the group financial statements exceeds the materiality level for the group financial statements as a whole, the component materiality level is set lower than the group materiality level.

2. Different materiality levels may be established for different components. …

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