Question

Why is net income before tax the most common base used to determine the preliminary judgement about materiality? In what circumstances might the auditor use a different base?

Answer 1

As per accounting concepts and conventions “ Any matter, amount, facts, items of financial statement will considered material if its directly or indirectly reasonably influence the decision of financial statement and audit report users. This is depends upon nature, timing and effect of such matter, amount, facts and items of financial statement.

In Income statement EBT (Earnings before Tax) considered as material item most of time by different users of financial statement and auditor, because it’s used to determine how much dividend is to be declare for equity share holder and preferred share holder? What will be the Income tax liability of organization? and how much will be retained earnings of organization based on this EBT.

Many times auditor use different base like EBIT ( Earnings before interest and taxes), Contribution margin, EAT(Earning after tax) rather than EAT , like:-

1.            When there are various operating fixed costs like Rent, Fixed wages and salary, Insurance etc cost exit in organization than Contribution margin and EBIT(Earnings before interest and taxes) can consider material item.

2.            If there are step fixe cost, than Contribution Margin can be consider a material item.

3.            If Company comes under special tax slab/tax concession/ tax relief/ tax exemption than EBT( Earning before tax) can be consider as material item.