Materiality for particular classes, balances and disclosures

• Identify when a lower materiality level is required under AU-C 320.10.
• Apply the indicators in AU-C 320.A13.
• Set and document a particular-item materiality level.

The requirement

AU-C 320.10 requires you to determine materiality for the statements as a whole. It then adds: if one or more particular classes of transactions, account balances or disclosures exist for which there is a substantial likelihood that misstatements of lesser amounts than overall materiality would influence the judgment of a reasonable user, you also determine the materiality level or levels for those items.

This is not optional when the condition is met. It recognizes that users read some items with a magnifying glass.

Indicators

AU-C 320.A13 lists factors that may indicate such items:

• Law, regulation or the framework affects user expectations about measurement or disclosure. Examples given: related party transactions, remuneration of management and those charged with governance, and sensitivity analysis for fair value estimates with high estimation uncertainty.
• Key industry disclosures. The example given is research and development costs for a pharmaceutical company.
• Attention focused on a separately disclosed aspect of the business, such as discontinued operations or a significant business combination.

AU-C 320.A14 notes you may find it useful to understand the views and expectations of those charged with governance and management.

Other situations practitioners consider: a covenant computed on a specific line item, a nonprofit's fundraising expense ratio watched by donors and rating services, and grant-funded program expenses watched by a grantor.

Setting the level

The standard gives no formula. Approaches:

• Start from the user decision. If a covenant requires EBITDA of $3 million and actual is $3.15 million, a misstatement of $150,000 changes the answer. The level for EBITDA components may need to be well below overall materiality.
• For disclosures such as executive compensation, consider what difference would change a reader's view. Often the level is small or qualitative: any misstatement of the CEO's pay is material.
• For a narrow class like related party transactions, a separate amount set as a fraction of overall materiality is common in methodologies.

Then set performance materiality for the item below its materiality level. AU-C 320.09 extends the definition of performance materiality to amounts set for particular items.

Using it

• Scope and procedures for the item are designed to its lower level.
• Misstatements in the item are evaluated against its level as well as overall materiality. AU-C 450.11(a) requires you to consider size and nature in relation to particular classes, balances and disclosures, and AU-C 450.A22 explains that each misstatement is considered for its effect on the relevant item, including whether that item's materiality level has been exceeded.
• Revise it when circumstances change (AU-C 320.12).

Documentation

AU-C 320.14(b) requires documentation of the particular-item materiality levels and the factors considered. If you considered the indicators and concluded none apply, a sentence recording that conclusion shows the requirement was addressed.

Common findings

• No consideration of particular items, even when related party transactions or covenants are prominent.
• A particular-item level set but never used in testing or evaluation.
• Disclosures such as executive compensation evaluated only against overall materiality.

The SAB 99 guide covers qualitative thinking that carries over to private-company judgments, and related party disclosures shows what the framework requires.

Related party leases at a family company