Audit Methodology

Audit Methodology Extension

Purpose

This extension encodes a firm's audit methodology standards as standing instructions for the assurance agent. When loaded, the agent applies these specific methodology choices — materiality benchmarks, sampling approaches, documentation standards, and escalation triggers — instead of generic audit procedures. Practitioners must customise this extension to match their firm's actual methodology manual.

Instructions

Materiality Calculation Methodology

When calculating materiality for an audit engagement, apply the following framework:

Step 1 — Select the benchmark:

• For-profit entities: Pre-tax profit from continuing operations (primary benchmark).
• If pre-tax profit is volatile (coefficient of variation > 30% over 3 years), use revenue as the benchmark instead.
• Loss-making entities: Revenue (primary) or total assets (secondary, for asset-intensive entities).
• Not-for-profit entities: Total expenses or total revenue, whichever is more stable.
• Public interest entities: Use the lower of two benchmark calculations to reflect heightened user expectations.

Step 2 — Apply the percentage:

• Pre-tax profit benchmark: 5% (standard), 3-4% (public interest entities or higher-risk engagements).
• Revenue benchmark: 0.5% to 1% (use the lower end for entities with tight margins).
• Total assets benchmark: 1% to 2%.
• Document the rationale for the specific percentage chosen within the range.

Step 3 — Calculate performance materiality:

• 65% of overall materiality (standard engagements).
• 50-60% of overall materiality (higher-risk engagements — first year audit, history of adjustments, weak internal controls).
• Document the risk factors that determined the percentage.

Step 4 — Set the trivial threshold (Clearly Trivial):

• 5% of overall materiality.
• Misstatements below this threshold are not accumulated unless they are qualitatively significant (e.g., related party, management remuneration, fraud).

Step 5 — Document and review:

• Materiality must be documented at the planning stage and reconsidered at completion when final financial results are available.
• If the final materiality is lower than the planning materiality, evaluate whether additional audit procedures are required for the affected areas.

Sampling Methodology

When selecting items for testing, apply these minimum sample sizes:

Statistical sampling (for substantive tests of details):

Non-statistical sampling (for tests of controls):

• Controls operating daily: Minimum 25 items (one per working day for a month, extended if exceptions found).
• Controls operating weekly: Minimum 5 items.
• Controls operating monthly: Minimum 2 items.
• Controls operating quarterly: All 4 occurrences.
• Controls operating annually: The single occurrence plus the supporting documentation.

When exceptions are found:

• 1 exception in sample: Increase sample by 50% and investigate the root cause.
• 2+ exceptions in sample: Consider the control or balance unreliable. Escalate to the engagement manager/partner and redesign the audit approach.

Documentation Standards

Every audit working paper must contain:

1. Working paper reference: Unique identifier cross-referenced to the audit programme.
2. Preparer and date: Who prepared the working paper and when.
3. Reviewer and date: Who reviewed it and when (leave blank for the reviewer to complete).
4. Objective: The specific audit objective this working paper addresses.
5. Source of data: Where the data tested came from (client system, confirmation, bank statement).
6. Work performed: Step-by-step description of the procedure, sufficient for an experienced auditor to understand what was done without needing supplementary explanation.
7. Results: Findings stated factually — what was found, not what was expected.
8. Exceptions: Each exception listed with: item reference, nature of exception, financial impact (actual and projected), and disposition (adjust/reclassify/waive with rationale).
9. Conclusion: Whether the objective was achieved, with cross-reference to the assertion and risk being addressed.

Sign-off requirements:

• All working papers must be prepared and reviewed before the audit report is signed.
• Working papers for significant risk areas must be reviewed by the engagement partner, not only the manager.
• Any working paper with unresolved exceptions must be escalated before sign-off.

Escalation Triggers

The following conditions require immediate escalation to the engagement partner (do not continue procedures without partner direction):

1. Fraud indicators: Unusual journal entries (post-closing, round amounts, unusual accounts), management override of controls, unexplained adjustments, tips or allegations.
2. Going concern doubt: Net current liability position exceeding 50% of net assets, recurring operating losses for 2+ years, covenant breach or approaching covenant limits, loss of major customer or key personnel.
3. Scope limitations: Client refuses access to records, key personnel unavailable, inability to attend inventory count, limitations on confirmation procedures.
4. Material misstatements: Any individual misstatement exceeding performance materiality. Aggregate misstatements exceeding 75% of overall materiality.
5. Significant estimates: Fair value measurements with high uncertainty, litigation provisions, impairment of goodwill or intangibles, expected credit loss models with significant judgment.
6. Independence threats: Any new relationship, financial interest, or business transaction identified during the engagement.
7. Disagreement with management: On accounting treatment, disclosure adequacy, or going concern assessment.

Independence and Rotation

• Confirm independence declarations are on file for all engagement team members before commencing fieldwork.
• For listed entity audits: engagement partner rotation required every 5 years (3 years cooling-off). Key audit partners rotation per local regulations.
• Document any new independence threats identified during the engagement and the safeguards applied.

Domain Context

This extension is loaded alongside the assurance agent skill (Domain 3). It encodes a firm's specific methodology choices that go beyond the minimum requirements of ISA. The materiality benchmarks, sampling tables, and escalation triggers in this template are based on common practice across mid-tier firms — large firms (Big Four) may have different thresholds, and smaller firms may apply simplified approaches for smaller engagements. Practitioners must verify these parameters match their firm's methodology manual.

Constraints

• NEVER reduce sample sizes below the minimums specified in this extension, even if the agent assesses risk as low
• NEVER skip the escalation triggers — if a condition is met, escalation is mandatory regardless of the agent's assessment of severity
• NEVER sign off working papers — the preparer and reviewer fields are for the human audit team
• NEVER adjust the materiality threshold downward during the engagement without recalculating and documenting the rationale
• This extension is a TEMPLATE — firms must replace these parameters with their own methodology before use in live engagements