Audit Materiality.

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Presentation transcript:

Audit Materiality

Audits provide reasonable assurance that the financial statements are Materiality Audits provide reasonable assurance that the financial statements are free of material misstatements.

Materiality – Definition (Framework) "Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of 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 cutoff point rather than being a primary qualitative characteristic which information must have if it is to be useful."

Materiality is defined in terms of financial statement users USER FOCUS Materiality is defined in terms of financial statement users Materiality can be on Qualitative/ Quantitative factors Therefore no hard and fast rules Need to consider multiple users and multiple bases

SET PRELIMINARY JUDGMENT ABOUT MATERIALITY Factors Affecting Judgment Base X (function of client) Percentage (function of audit risk) = Preliminary estimate of materiality

Materiality Percentage Typically 1 - 5% for net income, lower percentage for larger bases such as assets or revenues High Risk Low % ML Low Risk High % ML (less evidence; less assurance)

Materiality / Evidence Relation Increase in Materiality Level Less evidence required

Materiality Level /Materiality and Audit Risk There is a positive relationship between materiality level and audit risk There is a negative relationship between materiality and audit risk Materiality Level ⁭ = Audit Evidence ↓ = Audit Risk ⁭ Materiality ⁭ = Audit Evidence ⁭ = Audit Risk ↓

Materiality Should be Considered by the Auditor When: (a) Determining the nature, timing and extent of audit procedures; and (b) Evaluating the effect of misstatements.

Evaluating the Effect of Misstatements In evaluating whether the financial statements "give a true and fair view" or "present fairly, in all material respects,", the auditor should assess whether the aggregate of uncorrected misstatements that have been identified during the audit is material

Evaluating the Effect of Misstatements The aggregate of uncorrected misstatements comprises: (a) Specific misstatements identified by the auditor; and (b) The auditor's best estimate of other misstatements which cannot be specifically identified.

Evaluating the Effect of Misstatements When aggregate uncorrected misstatements approach the materiality level the auditor would consider reducing the risk by Performing additional audit procedures or By requesting management to adjust the financial statements for identified misstatements

Evaluating the Effect of Misstatements Example An auditor discovered an overstatement of Rs. 20,000/- of inventory by verifying a sample of 100,000/- worth of inventory. The B/S value of inventory is Rs. 200,000/-. The preliminary materiality level set by the auditor is Rs. 30,000/-. Required : Find if the misstatement is material or not.