Materiality at the Financial Statement Level

Financial statements are materially misstated when they contain errors or irregularities whose effect, individually or in the aggregate, is important enough to prevent the statements from being presented fairly following Accounting Standards. In this context, misstatements may result from misapplication of applicable Accounting Standards, departures from fact, or omissions of the necessary information.

The financial statement materiality at the financial statement level enables auditors to determine which account balances to audit and how to evaluate the effects of misstatements in financial information as a whole. In audit planning, the auditor should recognize that there may be more than one level of materiality relating to the financial statement. Each statement could have several levels.

For the Income Statement, materiality could be related to total revenues, operating profit, net profit before tax, or net profit. For the Statement of Financial Position, materiality could be based on shareholders’ equity, assets, or liability class total. The auditor’s preliminary judgments about materiality are often made six to nine months before the balance sheet date. Thus, the judgments may be based on annualized interim financial statement data.

Alternatively, they may be premised on one or more prior years’ financial results adjusted for current changes, such as the general condition of the economy and industry trends. Materiality judgments involve both quantitative and qualitative considerations.

Materiality at the Account Balance Level

Account balance materiality is the minimum misstatement that can exist in an account balance for it to be considered materially misstated.

Misstatement up to that level is known as a tolerable misstatement. The concept of materiality at the account balance level should not be confused with the term material account balance.

The latter term refers to the size of a recorded account balance, whereas the concept of materiality pertains to the amount of misstatement that could affect a user’s decision. The recorded balance of an account generally represents the upper limit on the amount by which an account can be overstated.

Thus, accounts with balances much smaller than materiality are sometimes said to be immaterial in terms of the risk of an overstatement.

However, there is no limit on the amount by which an account with a very small recorded balance might be understated.

Thus,.it should be realized that accounts with seemingly immaterial balances may contain understatements that exceed materiality.

Materiality at the account balance and class of transaction-level assists auditors in determining what items in a balance or class to audit and what audit procedures to undertake; for example, whether to use sampling or analytical procedures.

In making judgments about materiality at the account balance level, the auditor must consider the relationship between it and financial report materiality.

This consideration should lead the auditor to plan the audit to detect misstatements that may be immaterial individually, but that may be material to the financial report taken as a whole when aggregated with misstatements in other account balances.

In making judgments about materiality at the account balance level, the auditor must consider the relationship between it and financial statement materiality.

This consideration should lead the auditor to plan the audit to detect misstatements that may be immaterial individually, but that, when aggregated with misstatements in other account balances, may be material to the financial statements taken as a whole.