All people may be created equal, but the same can’t be said for customers. Everyone knows that some customers are more profitable than others. Conversely, some are downright unprofitable. Knowing which is which is the all-important question.

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.

Guidance in the Auditing Standards

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.

This article has been excerpted from the Journal of Accountancy.
View the full article here.