Video: Types of Materiality

In this lesson, Nick Palazzolo, CPA, discusses the different types of materiality that auditors use in evaluating financial statements. He explains the concept of overall materiality, which is the maximum amount by which financial statements can be misstated and still be considered free from material misstatements. The lesson then covers performance materiality, a threshold usually lower than overall materiality, used to assess transactions, account balances, and disclosures. Finally, specific materiality is introduced, focusing on individual amounts or items that may have a material impact on the financial statements. Nick emphasizes the importance of understanding and distinguishing between these types of materiality, ensuring a thorough assessment of the financial statements.

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Video Transcript

Instructor: Nick Palazzolo

Nick Palazzolo is head instructor of ExamPrep.ai CPA Review. Nick's teaching style is engaging & upbeat, combining practical Big 4 tax & assurance expertise with years of 1-on-1 coaching. His lessons are concise and emphasize what you need to know to pass. Whether you're a recent grad or working full-time, we’re confident you can conquer your CPA exams with Nick’s review.

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As I mentioned previously, we are going to talk about different types of materiality. First, we're going to start with overall materiality. And these will be actually different numbers. So when we're doing the actual audit, we're going to have a number for overall materiality, a number for PM, a number for specific materiality. The overall materiality is the maximum amount that the financial statements as a whole can be misstated and still be considered free material misstated. Let's say cash is off by, and I'm just going to use super small, nice numbers. Let's say cash is off by $10. AP is off by $20. And I'm just going to stop there. Now, if overall materiality is $25, oh, well, it looks like as a whole, these are misstated at $30, whereas the overall materiality was at 25. So we're $5 over that, meaning we can't issue these financial statements because they are materially misstated. However, we've got other materiality thresholds, such as performance materiality. This is going to be usually less than overall materiality. And this is going to take into account materiality at the transaction class, account balance, or disclosure level. So something could be overall material and material performance-wise. Let's take this into account. Like I said, this is cash and this is AP. If performance materiality is $12, well, that means cash is not material, but AP is $20 over. So this would be material. We see how there's different thresholds, and these are all important because we want to assess the overall financial statements. We want to assess each transaction class, so expenses, revenues, account balances, assets, liabilities, and disclosure levels. Did the financial statements fail to disclose a bunch of lawsuits, pending lawsuits, contingencies, and commitments? Something we're going to take into account

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