What is materiality? Is materiality measured the same way across different autho
ID: 2416821 • Letter: W
Question
What is materiality? Is materiality measured the same way across different authoritative bodies? What factors would you use on an audit to determine materiality? Can you give an example when two auditors do not agree on an issue that may or not be material and how would you as a third auditor resolve it? What is materiality? Is materiality measured the same way across different authoritative bodies? What factors would you use on an audit to determine materiality? Can you give an example when two auditors do not agree on an issue that may or not be material and how would you as a third auditor resolve it?Explanation / Answer
In Auditing, Material Items are “items the knowledge of which would influence the decisions of the users of the financial statements”. Whether an item is material or not depends on the particular facts and circumstances of each case.
While risk determines the likelihood of occurrence of the error, materiality determines the extent to which such errors can be tolerated.
Materiality can be decided on the following basis (Types)
1.Materiality by Value;
2. Materiality by Nature;
3. Materiality by Context
Each of these can be explained as follows:
1.Materiality by Value;
The point where the total value of errors in an account becomes unacceptable to Audit, so that Auditor would have to qualify the audit opinion, is called the materiality level of that account.
Examples:
•% on net profit – for profit oriented units
•% on revenue or total expenses- non profit
2. Materiality by Nature;
If the error affect a figure in the accounts which users expect to be stated with a high degree of accuracy or if the figure is likely to be of great interest to the users.
Example:
–Items that need to be shown separately because of their exceptional nature;
–A capital expenditure is wrongly classified as revenue expenditure.
3. Materiality by Context:
If the error is material because of its implication on other aspects of the accounts
Example:
Due to a misstatement, the financial statements indicate that a department has savings when it has, in fact, exceeded its budget, it will become material by context as an excess would require regularisation by the upper authority.
General points the Auditor has to keep in mind while assessing materiality(Answer to Last part of the question):
Materiality is relative concept rather than absolute (i.e what may be material in one circumstance may not be material in another circumstance).
Materiality can be judged from the impact of the item at the over –all financial statement level(Income statement and Balance sheet) and /or at the individual account balance or class of transactions (Sales, Purchases, Cash, Bank, sundry debtors, Creditors).
Materiality can also be judged for an item on its comparison with the corresponding figure of the previous year.
Cumulative effect of small amounts may be considered material if collectively they influence economic decision of users.
Materiality is also influenced by applicable legal or regulatory requirements pertains to entity which is audited.
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