Materiality is often a matter of judgments and can
be a particularly difficult matter in practice but is of great importance.
Great care should be taken before coming to a conclusion on matters of
materiality.
be a particularly difficult matter in practice but is of great importance.
Great care should be taken before coming to a conclusion on matters of
materiality.
ISA 320 audit materiality states:
Information is material if its omission or
misstatement could influence the economic decisions of users taken on the basis
of the financial statements…
misstatement could influence the economic decisions of users taken on the basis
of the financial statements…
The assessment of what is material is a matter of
professional judgments.
professional judgments.
In addition to that, the companies act is full of
refences to materiality. For example, there must be shown separately in the
profit and loss account the amount, if material, charged to revenue in respect
of sums payable for the hire of plant and machinery.
refences to materiality. For example, there must be shown separately in the
profit and loss account the amount, if material, charged to revenue in respect
of sums payable for the hire of plant and machinery.
Materiality is a matter of professional judgments
and it has both quantitative (amount) and qualitative (nature) dimensions.
and it has both quantitative (amount) and qualitative (nature) dimensions.
Quantitative estimates
For example a figure might be material purely
because of its size relative to other amounts in the accounts. Auditors often
set some form of percentage values on errors which will decide if they are
material or not, for example.
because of its size relative to other amounts in the accounts. Auditors often
set some form of percentage values on errors which will decide if they are
material or not, for example.
·
5-10% of
pre-tax profits;
5-10% of
pre-tax profits;
·
1% of
turnover;
1% of
turnover;
·
5% of net
asset value.
5% of net
asset value.
However, this should not be taken as being
prescriptive-the actual amount decided on will be a matter of professional judgments.
prescriptive-the actual amount decided on will be a matter of professional judgments.
For example, a sum might be quite small but is
sufficient to turn a pre-tax profit into a pre-tax loss. This would almost
certainly be material as it would be likely to influence the economic decisions
of a reader of the accounts. There are some methods by which auditors can
assess whether or not items are material:
sufficient to turn a pre-tax profit into a pre-tax loss. This would almost
certainly be material as it would be likely to influence the economic decisions
of a reader of the accounts. There are some methods by which auditors can
assess whether or not items are material:
·
Compare
the magnitude of the item with the overall view presented by the accounts.
Compare
the magnitude of the item with the overall view presented by the accounts.
·
Compare
the magnitude of the item with the magnitude of the same item in previous
years.
Compare
the magnitude of the item with the magnitude of the same item in previous
years.
·
Compare
the magnitude of the item with the total of which it forms a part (e.g.
‘debtors’ may include employee loans but if employee loans become large, i.e.
material, then the description ‘debtors’ may be inadequate.
Compare
the magnitude of the item with the total of which it forms a part (e.g.
‘debtors’ may include employee loans but if employee loans become large, i.e.
material, then the description ‘debtors’ may be inadequate.
·
Some
items are always material, e.g. directors’ remuneration.
Some
items are always material, e.g. directors’ remuneration.
Qualitative estimates
Materiality also has qualitative aspects and these
relate to the nature of the error or misstatement detected, regardless of its
financial value.
relate to the nature of the error or misstatement detected, regardless of its
financial value.
For example, errors which are material by virtue of
their nature would include:
their nature would include:
·
Omission
of a disclosure required by the companies act or accounting standards.
Omission
of a disclosure required by the companies act or accounting standards.
·
An item
which is misstated in the accounts- e.g. a short-term loan classified as a
long-term loan.
An item
which is misstated in the accounts- e.g. a short-term loan classified as a
long-term loan.
·
An item
which might affect the accounts but which has been omitted because it cannot be
quantified with a reasonable degree of certainty e.g. the outcome of a court
case.
An item
which might affect the accounts but which has been omitted because it cannot be
quantified with a reasonable degree of certainty e.g. the outcome of a court
case.
In these cases the auditors should remind the
directors of their duty to comply with the companies act and the accounting
standards and rectify omissions or misstatements.
directors of their duty to comply with the companies act and the accounting
standards and rectify omissions or misstatements.
Materiality and audit procedures
Auditors should take materiality into account when
considering the nature, timing and extent of audit procedures.
considering the nature, timing and extent of audit procedures.
Materiality should be taken into account at the
planning stage and reconsidered if the outcome of tests, enquiries or
examinations differs from expectation.
planning stage and reconsidered if the outcome of tests, enquiries or
examinations differs from expectation.
In evaluating whether the financial statements give
a true and fair view, auditors should assess the materiality of the aggregate
or total of uncorrected errors. These may be those identified during the audit
and the best estimate of others which the auditors have not quantified
specifically. Examples might be numerous small errors in the sales ledger or in
coding expense invoices. If the directors adjust the financial statements for
these all may be well, but if not the aggregate misstatement may be material
when each individual misstatement is not.
a true and fair view, auditors should assess the materiality of the aggregate
or total of uncorrected errors. These may be those identified during the audit
and the best estimate of others which the auditors have not quantified
specifically. Examples might be numerous small errors in the sales ledger or in
coding expense invoices. If the directors adjust the financial statements for
these all may be well, but if not the aggregate misstatement may be material
when each individual misstatement is not.