Question

Materiality

Define the concept of materiality.

How does one determine what materiality is and how is it applied to an audit?

Answer 1

How to Determine Materiality:

Auditors make a preliminary assessment of materiality of the financial statements as a whole by determining the amount by which the believe the financial statements could be misstated without affecting user’s decisions. This amount is called “Preliminary judgment about materiality” or “planning materiality”. This judgment need not be quantified but often is. It is called a preliminary judgment about materiality because it is a professional judgment and may change during the engagement if circumstances change. The reason for determining “planning materiality” is to help the auditor plan the appropriate evidence to accumulate. If the auditor set a low peso amount, more evidence is required than for a high amount.

In establishing planning materiality or preliminary judgment about materiality, an auditor must also consider any potential effect a misstatement might have which may be greater than the peso amount involved. A misstatement which may not be material based on quantitative factors but does not allow a client to meet a condition in a contractual obligation or expectations of a financial statement user may be considered material. In these instances, amount of planning materiality based on the users expectations of income or alter those working on the engagement to the potential for these types of material misstatement.

Other Considerations:

When accepting new audit engagement, inquire about the overall materiality used by the previous auditor. If available, this would help in determining whether further audit procedures may be required on the opening asset and liability balances.

Ensure that any experts employed by the entity (to assist the entity in preparing the financial statements) or used by the audit team are instructed to use an appropriate materiality level in relation to the work they perform.