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) , Can you provide reference also.

Answer 1

(a) Determination of materiality is a matter of auditor’s judgement. When auditors audit the accounts they cannot check out every single transaction. In those cases, the auditor may take decisions on ignoring some of the accounting principles which does not have a significant impact on the business.

To set up a level of materiality, auditors depend on rules of thumb and professional judgment . They also consider the amount and type of misinformation. Judgment is affected by the auditor’s perception of the financial information needs of users of the financial statements.Information is material if its omission or misrepresentation could influence the economic decision of users taken based on the financial statements.

Materiality depends on the size of the error found  in the particular circumstances of its omission or misstatement.When establishing the overall audit strategy, the auditor should determine materiality for the financial statements as a whole.If, in the specific situations of the entity, one or more particular classes of transactions, ac- count balance, or disclosures exist for which there is a substantial likelihood that misstatements of less amounts than materiality for the financial state- ments as a whole would influence the judgment made by a reasonable user based on the financial statements, the auditor also should determine the materiality levels to be applied to those particular classes of transactions, account balances, or disclosures.

(b) The information we provide to the auditor affects the assessment of preliminary materiality. A preliminary judgment about materiality is set for the financial statements as a whole. Tolerable misstatement is the maximum amount of misstatement that would be considered material for an individual account balance. The amount of tolerable misstatement for any given account is dependant upon the preliminary judgment about the materiality. Ordinarily, tolerable misstatement for any given account would have to be lower than the preliminary judgment about materiality.

Factors affecting the preliminary judgment about materiality are as follows:

1. Materiality is a relative rather than an absolute concept.

2. Bases are needed for evaluating materiality.

3. Qualitative factors affect materiality decisions.

4. Expected distribution of financial statements will affect the preliminary judgment of materiality. If the financial statements are widely distributed to users, the preliminary judgment of materiality will probably be set lower than if the financial statements are not expected to be widely distributed.

5. The level of acceptable audit risk will also affect the preliminary judgment of materiality.