CIA.Mat

Question: When can a discrepancy be ignored? Answer: When it is 'small enough' not to matter. (In other words, when it's not material.) Memorize the definition of materiality and considerations in selecting a materiality level.   Forum

Pop Quiz

Alice the Actuary just accepted an actuarial job offer at a salary of $120,000. Woo-hoo!

• But the next day, HR called and said they'd made a mistake. The salary is only $119,500. Do you think she would accept the revised offer?
• What if the revised offer were $115,000, or $110,000, or even lower.

Question: How low do you think HR could go before Alice would reject the revised offer?

BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

• materiality definition
• setting materiality level based on company characteristics [Hint: F-STARS] (Thx user xQEDx!)
• determining an appropriate metric (percent of surplus, net income, etc) for testing materiality for a given purpose (regulation, appraisal, general purpose)

Top Questions ← Questions you absolutely need to know!

reference	part (a)	part (b)	part (c)	part (d)
E (2019.Spring #23)	materiality: - definition	setting materiality: - company characteristics	disclosure of materiality: - considerations SIC	materiality level: - valuation v DCAT
E (2018.Fall #20)	CIA.DCAT	CIA.DCAT	(c) CIA.DCAT (d) CIA.DCAT	(e) setting materiality: for DCAT (f) CIA.DCAT
E (2017.Fall #30)	materiality: - definition	testing materiality: - appropriate metrics	setting materiality: - company characteristics
E (2015.Fall #28)	materiality: - definition	setting materiality: - company characteristics
E (2015.Spring #33)	materiality: - definition	setting materiality: - company characteristics
E (2014.Spring #34)	setting materiality: - main concept	materiality: - definition	materiality level: - valuation v DCAT
E (2013.Fall #22)	see CIA.Taxes	materiality: - definition	see CIA.Taxes

In Plain English!

This paper is easy and if you only have 20 minutes to study it, cover the definition of materiality, and the company characteristics in setting the materiality level. For most of the past exams, you would get all the points just from learning those 2 things.

Definition of Materiality

Th definition has been asked many times. (See BattleTable above.)

Question: state the definition of materiality

An omission / under-statement / over-statement is material...

...if the actuary expects it to materially affect the user's decision-making or reasonable expectations.

This definition is taken from the reading, but it's a poor definition. Do you see why? It's circular. It uses the term it is trying to define: What does "materially affect" mean? Just for fun, I tried to come up with a better definition. Here's mine with my changes in italics:

An omission / under-statement / over-statement is material...

...if the actuary expects it to change the user's decision or expectations versus the scenario where there has been no omission / under-statement / over-statement.

You should memorize the official definition from the reading, but I just wanted to give my 2 cents.

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Considerations in Setting Materiality Level - Company Characteristics

This question has also been asked multiple times. (See BattleTable above.)

The 6 considerations in setting the materiality level, based on company characteristics are: [Hint: F-STARS] (Thx to xQEDx!)

F   FINANCIAL strength (SOP 1340.04) (One of the examiner's reports said this was not a valid answer, but I don't know why not.)

–

S   SIZE (of entity)

T   TYPE of business

A   ACCESS (to capital)

R   net RETENTION

S   STAGE (of organization's life cycle)

The past exam questions simply asked you to list either 2 or 3 of these items (but it isn't much more work to memorize all 6, if you have a good memory trick.)

A better type of question, however, is to present you with facts about 2 different companies, and ask which would have a higher/lower materiality level.

Pop Quiz: Which company would likely have a lower materiality level regarding its net income?

Company A: incorporated in 1970

Company B: incorporated in 2016

Answer: Company B. It's at a much earlier stage in its organizational life cycle. Its net income is likely much lower so smaller swings in net income would have a proportionately greater impact on decision-making (versus Company A.)

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Considerations in Setting Materiality Level - Intended Users

In the previous section, we covered 6 company characteristics related to setting a materiality level, but we didn't provide a mathematical method for actually calculating it. This paper doesn't go into detail on this, but there is something that shows up on the exam occasionally.

Recall the overall main consideration in setting a materiality level: use of work & intended users. The following table provides 3 'uses/users' and suggests a basis for the materiality level.

use	user	basis for materiality
regulation, solvency monitoring	regulator	statutory surplus, solvency benchmark ratio
appraisal	investor	net worth, net income, EPS (Earnings per Share)
general purpose financial statements	competitors rating agencies management	statutory surplus, net income

Of course, we still don't have an actual number for the materiality level, but an easy rule is to select a percentage of the basis. For example, a regulator might select 5% of surplus, whereas a general purpose user might select 10% of surplus. The materiality level for solvency purposes would be more rigorous (or lower) than for a general user. The regulator would want to detect smaller movements in the financials and take corrective action before small problems grow large. (Alice needs to apply this to her credit card bill!)

There is an old exam question in the mini BattleQuiz that was kind of hard: (2014.Spring #34c)

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Disclosure and Reporting

This first item is actually a pretty good question and I have a good memory trick for it. (Alice made me include the second item because she's OCD. But between you and me, I think it has < 1% probability of being on the exam!)

Question: identify considerations regarding the disclosure of materiality in actuarial communications [Hint: SIC]

Sophistication of user

Importance of concept to user

Complexity of concept (KISS: Keep it Simple Stupid!)

Question: identify possible actions of a report-writer based on materiality [Hint: IRD]

Include item?

- ask yourself whether the item should be considered

Refine item?

- ask yourself whether the item is sufficiently accurate

Disclose item?

- ask yourself whether the item should be reported

Like I said, these items haven't been asked before, but the first one is easy. It's just another way of saying you should take into account your user/audience when communicating.

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BattleCodes

Memorize:

• definition of materiality
• 6 considerations in setting materiality level
• miscellaneous facts from the BattleCards (see BattleQuiz below - I didn't list everything here because it's very straightforward.)

Conceptual:

• Given info about 2 different companies, can you comment on which would have a higher/lower materiality level relative to a given financial metric.

Calculational:

• none

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  Forum

POP QUIZ ANSWERS

Obviously this question doesn't have a single correct answer. (For Alice, it depends on this month's credit card bill!)

• Let's suppose Alice would be willing to accept $115,000, but nothing less.
• Then the level of materiality in this situation would be $5,000. That's because any reduction less than $5,000 would not affect her decision. But any reduction more than $5,000 would affect her decision.

That's the idea behind materiality: What is the smallest amount that would affect your decision?