Question

Discuss materiality as it relates to the accounting/auditing profession? When is it appropriate to just "let it go" when balancing bank accounts?

Answer 1

In terms of ISA 200, the purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. The auditor expresses an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework, such as IFRS. ISA 320, paragraph A3, states that this assessment of what is material is a matter of professional judgement.

The concept of materiality is applied by the auditor both in planning and performing the audit, and in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report.

ISA 320, paragraph 10, requires that "planning materiality" be set prior to the commencement of detailed testing. ISA 320, paragraph 12 requires that materiality be revised as the audit progresses, if (and only if) information is revealed that, if known at the onset of the audit, would have caused the auditor to set a lower materiality. In practice, materiality is re-assessed at least once, during the conclusion of the audit, prior to the issuing of the audit report. This materiality is referred to as "final materiality".

ISA 320, paragraph 11, requires the auditor to set "performance materiality". ISA 320, paragraph 9, defines performance materiality as an amount or amounts that is less than the materiality for the financial statements as a whole ("overall materiality"). It includes materiality that is applied to particular transactions, account balances or disclosures. Paragraph 9 also states that the purpose of setting performance materiality is to reduce the risk that the aggregate total of uncorrected misstatements could be material to the financial statements.

In terms of ISA 320, paragraph A1, a relationship exists between audit risk and materiality. This relationship is inverse. The higher the audit risk, the lower the materiality will be set. The lower the audit risk, the higher the materiality will be set.

In terms of the Conceptual Framework (see "materiality in accounting" above), materiality also has a qualitative aspect. This means that, even if a misstatement is not material in "Dollar" (or other denomination) terms, it may still be material because of its nature. An example is if a disclosure is omitted from the financial statements.

THE SARBANES-OXLEY REQUIREMENT FOR COMPANIES to develop key control processes has brought new attention to the well-known concept of materiality. CPAs need to be able to identify key control exceptions and apply materiality to determine their financial impact.

MATERIALITY IS BASED ON THE ASSUMPTION a reasonable investor would not be influenced in investment decisions by a fluctuation in net income less than or equal to 5%. This “5% rule” remains the fundamental basis for working materiality estimates.

WHEN REVIEWING THE MATERIALITY OF FINANCIAL statement misstatements that are uncorrected/unrecorded, an error can fall into three ranges—inconsequential, consequential and material. Companies must record errors that fall within the material misstatement range for the independent auditor to give an unqualified opinion.

COMPANIES SHOULD BASE WORKING MATERIALITY levels for control deficiencies on PCAOB Auditing Standard no. 2, which says consequential control deficiencies must be reported to the registrant’s audit committee under Sarbanes-Oxley section 302.

ACCOUNTING ESTIMATION PROCESSES GENERALLY do not result in control deficiencies or uncorrected/unrecorded misstatements if they are reasonable. If the estimation process is flawed, broken or unreasonable, then a related control deficiency exists.