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How to set component materiality for a group audit?

If a parent company has multiple subsidiaries that are material to the overall business, then the group audit team will have component audit teams to performs audit of those subsidiaries. Now, overall materiality is set at the parent company / group level, however, the audit team needs to assign materiality to each component audit (i.e. component materiality).

Now, the question is, how do you allocate the group materiality to each component. There is no set method, but the AICPA/PCAOB have provided several guidelines to be followed:

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.

3) The component materiality level need not be an arithmetical portion of the group materiality level and, consequently, the aggregate of the component materiality levels may exceed the group materiality level.

So as an example, if “group materiality” is $9,000, and there are 3 components, then we should think about how to set materiality for each of the components.

It would be way too risky to set component materiality at $9,000 for each of the components since that is equal to the group materiality. If component materiality was set at $9,000, then there is a chance that misstatements at the component level could go undetected, and when aggregated with other components, the total undetected misstatement could exceed group materiality of $9,000.

Ultimately, the audit team should use their judgement and set materiality at various levels below $9,000 based on the size, complexity, and other factors of the specific component.

Despite your component materiality levels, the “clearly trivial threshold” is determined at the group level and is the same for all components regardless of component materiality.

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