Materiality in Auditing
Materiality is a concept or convention within auditing and accounting relating to the—importance significance of an amount, transaction, or discrepancy.
The auditor’s determination of materiality is a matter of professional judgment and is affected by the auditor’s perception of the financial information needs of users of the financial statements.
Information is material if its omission or misstatement could influence the economic decision of users taken based on the financial statements.
Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement.
Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.
Materiality is a major consideration in determining the appropriate audit report on the issue.
EASB 2 has defined materiality as, “The magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances make it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement
The auditors’ responsibility is to determine whether financial statements are materially misstated. If the auditor determines that there is a material misstatement, he or she will bring it to the client’s attention so that a correction can be made.
If the client.refuses to correct the statements, a qualified or an adverse opinion must be issued, depending on how material the misstatement is.
Therefore, auditors must have a thorough knowledge of the application of materiality. Materiality is relative to the size and particular circumstances of individual companies.
Example – Size
A default by a customer who owes only $1000 to a company having net assets of worth $10 million is immaterial to the financial statements of the company.
However, if the amount of default were, say, $2 million, the information would have been material to the omission of the financial statement of which could cause users to make incorrect business decisions.
Example – Nature
If a company is planning to curtail its operations in a geographic segment which has traditionally been a major source of revenue for the company in the past, then this information should be disclosed in the financial statements as it is by its nature material to understanding the entity’s scope of operations in the future.
The auditor makes preliminary judgments about materiality levels in planning the audit.
This assessment, often referred to as planning materiality, may ultimately differ from the materiality levels used after the audit in evaluating the audit findings because;
1. the surrounding circumstances may change, and
2. additional information about the client will have been obtained during the audit.
In planning an audit, the auditor should assess materiality at the two levels:
1. the financial statement level, and
2. the account balance level.