The determination of materiality thresholds in Maltese private sector audits

Abstract

PURPOSE: This study sets out (i) to ascertain the major quantitative and qualitative factors influencing the determination of materiality thresholds in the private sector external audits performed by large and medium-sized Maltese audit firms, (ii) to assess the effectiveness of ISA 320 in the determination of such materiality thresholds, as well as the impact of introducing more prescriptive guidelines within the Standard, and (iii) to assess the current level of professional judgement and its effectiveness in determining materiality thresholds, as well as to ascertain the typical challenges involved in exercising such judgement. DESIGN: A predominantly qualitative mixed-methods approach was adopted. Semi-structured interviews were carried out with twelve audit partners from large and medium-sized Maltese audit firms. FINDINGS: The findings indicated that the major quantitative factors influencing overall materiality are 5-10% of profit before tax and 1-3% of total revenue. The major quantitative factor influencing performance materiality and the clearly trivial threshold is 75% and 5% of overall materiality, respectively. Additionally, the major qualitative factors influencing materiality thresholds are fraud and litigation risk, quality of client internal controls, auditor critical thinking skills, client complexity, the client’s sector and a change in auditor. Furthermore, the findings indicated that, overall, ISA 320 provides sufficient guidance on the determination of materiality thresholds. Moreover, the most cited benefit of introducing more prescriptive guidelines within the Standard was greater consistency among auditors, while the most cited drawback was the limitation on professional judgement. The findings also revealed that professional judgement is crucial and generally effective in determining materiality thresholds. However, auditors typically face a few challenges when exercising such judgement, of which time pressure and the setting of appropriate thresholds are particularly significant. CONCLUSIONS: The study concludes that a clear understanding of the various quantitative and qualitative factors influencing materiality thresholds will enable auditors to set such thresholds appropriately. Furthermore, it is evident that the determination of materiality thresholds requires a balance between following the guidance provided by ISA 320 and exercising professional judgement. IMPLICATIONS: This study attempts to raise awareness of how large and medium-sized Maltese audit firms determine materiality thresholds. The proposed recommendations may aid ISA 320 and the Maltese Accountancy Board to provide clearer and additional guidance in order to ensure that auditors set appropriate materiality thresholds.