Question

One of the clients of MMM Chartered Accountants operates a restaurant. From January of the current year, the business has consistently paid its suppliers late, well in excess of the suppliers' normal credit terms. This has resulted in some suppliers requesting cash on delivery from the business. The auditor has reviewed the correspondence between the business and its bank and finds that the business has been experiencing cash flow problems for two years. Required: (a) Explain why determination of materiality is a matter of auditor judgment. Refer to both qualitative and quantitative materiality assessments . (150 - 200 words) (b) Explain whether (and, if so, how) the information provided impacts on the auditor's assessment of preliminary materiality . (250 - 300 words)

Answer 1

Material items are those items which may affect the judgement of users of financial statements.Misstatements including omissions are material if they indivisually or in aggregate influence the economic decisions of users taken on the basis of the financial statements.It depends upon Size of item,Nature of items and Statutory provisions.Materiality is to be considered from indivisual's point of view as well as overall financial statements.

The auditor’s determination of materiality is a matter of professional judgment and is affected by the auditor’s perception of the financial information needs of users of the financial statements.

Materiality may be Qualitative or Quantitative. Both the amount (quantity) and nature (quality) of misstatements are relevant to deciding what is material.

For example, Lets first talk about how size(quantitative) affects materiality:

A default by a customer who owes only $1500 to a company having net assets of worth $15 million is immaterial to the financial statements of the company.

However, if the amount of default were, say, $5 million, the information would have been material to the omission of the financial statement of which could cause users to make incorrect business decisions.

Now lets talk about how Nature(qualitative) affects materiality:

If a company is planning to curtail its operations in a geographic segment which has traditionally been a major source of revenue for the company in the past, then this information should be disclosed in the financial statements as it is by its nature material to understanding the entity’s scope of operations in the future.

The auditor generally makes preliminary judgements about materiality.However if the auditor obtains any such information that would have caused the auditor to have determined a different amount initially,he may revise the materiality for financial statements as a whole or for a particular class of transactions as the case may be. The revision of materiality can be done in the following cases:

- There is any change in circumstances or surroundings.

- Any new information is obtained later on which affects the financial statements ans its user's decisions.

-There is change in auditor's understanding of the entity.