Materiality and audit resourcing under a tight budget
Danau Bank Berhad reports profit before tax of RM 240 million and total assets of RM 19.6 billion. The audit committee approved overall materiality at 5% of PBT and performance materiality at 75% of overall materiality. For the FY2025 audit, the CAE notes: (i) a RM 62 million judgemental ECL management overlay, up from RM 18 million; (ii) wealth-management fee income grew 28% after a new digital onboarding journey; (iii) CET1 is 14.8% against an internal target of 15.0% and a regulatory minimum of 11.5%; (iv) a draft finding estimates RM 7.5 million of the ECL overlay lacks supporting evidence, and Finance says the adjustment would reduce CET1 by 12 basis points; (v) the audit budget is 2,400 hours, 10% below last year, with two auditors lost. The AC wants assurance on ECL and digital onboarding, while the CEO asks for 'no surprises'. The external auditor has flagged ECL as a significant risk.
1. Calculate overall and performance materiality and assess whether the RM 7.5 million ECL finding is material, considering both quantitative and qualitative factors.
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Calculation
- Overall materiality = 5% × RM 240 million = RM 12 million.
- Performance materiality = 75% × RM 12 million = RM 9 million.
The RM 7.5 million ECL finding is 62.5% of overall materiality and 83.3% of performance materiality. Quantitatively it is below overall materiality but above performance materiality, so it is not 'clearly trivial' and cannot be waived without further work.
Qualitative assessment The amount is material in context for several reasons:
- It would reduce CET1 by 12 basis points. CET1 is already 20 basis points below the internal target of 15.0%, so the adjustment widens an existing risk-appetite breach even though the regulatory minimum is not breached.
- ECL is a significant risk flagged by the external auditor and is inherently judgemental; an unsupported overlay affects the credibility of the entire ECL estimate, not just RM 7.5 million.
- A regulator may treat an unsupported management overlay as a governance and financial reporting weakness, even if the number is below overall materiality.
- The finding could indicate a bias pattern. If management has a history of optimistic overlays, the auditor should evaluate the cumulative effect, not only this one item.
I would therefore treat the finding as material for reporting and follow-up purposes, require management to support or adjust it, and evaluate whether the remaining overlay is similarly affected.
2. Allocate the 2,400-hour budget across ECL, digital onboarding and core financial audit. Justify the allocation and identify what you would de-scope.
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I would allocate by risk and by the evidence needed to support the audit conclusion, not by last year's budget.
| Area | Hours | % | Rationale |
|---|---|---|---|
| ECL overlay and credit models | 1,080 | 45% | Significant risk, external auditor flag, RM 62 million judgement, 12 bps CET1 impact, need for independent re-performance and model challenge |
| Digital onboarding and wealth fees | 600 | 25% | 28% growth, new journey, fraud and AML/CFT exposure, fee recognition risk |
| Core financial audit and controls | 600 | 25% | Financial statement assertions, ITGCs, branch and treasury coverage |
| Contingency | 120 | 5% | Overruns, issue follow-up and AC reporting |
This is tighter than last year, so I would de-scope lower-risk branch cash counts, routine compliance testing where prior-year results and monitoring evidence are strong, and duplicate control testing that can be replaced by data analytics. I would not de-scope ECL model challenge or digital onboarding. I would also consider using an ECL specialist for 80–100 hours within the ECL allocation, and use full-population analytics for fee and onboarding testing to reduce sample sizes.
The AC should be told explicitly what coverage was reduced and what risk is accepted. A 10% budget cut should not be hidden inside optimistic time estimates.
3. How should the CAE handle the CEO's 'no surprises' request when the ECL finding is unresolved at the time of the AC meeting?
Read the worked answer
The CAE should interpret 'no surprises' as a request for early, factual communication-not as a request to delay or suppress a finding.
- Brief the CEO and CFO before the AC meeting on the draft finding, the evidence obtained, the unresolved points and the possible effect. This reduces surprise without surrendering the AC's right to receive the finding.
- Report the finding as open and unresolved. The paper should distinguish confirmed facts from matters under discussion and include management's response. It should not be labelled 'final' if management has not had a reasonable opportunity to respond.
- Do not trade the finding for a quieter meeting. If the CEO asks for removal, the CAE should explain that the AC must receive material control and reporting issues and that the CAE has a professional obligation to report.
- Escalate to the AC chair if pressure continues or if management attempts to edit the paper after submission.
- Document the timing of communication, what management said and what changed. If the finding is later resolved, the CAE should record the evidence that resolved it.
The AC can then decide whether the matter affects the audit opinion, the risk rating or the remediation timetable. The CAE's job is to ensure the AC is fully informed, not to guarantee that the CEO is never surprised.