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

Materiality in Planning and Performing an Audit

states that financial reporting frameworks often discuss the concept of materiality in the context of the preparation and presentation of financial statements. Although financial reporting frameworks may discuss materiality in different terms, they generally explain that :

• Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements;
• Judgments about materiality are made in light of surrounding circumstances, and are affected by the size or nature of a misstatement, or a combination of both; and
• Judgments about matters that are material to users of the financial statements are based on a consideration of the common financial information needs of users as a group. The possible effect of misstatements on specific individual users, whose needs may vary widely, is not considered.

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. In this context, it is reasonable for the auditor to assume that users :

1. Have a reasonable knowledge of business and economics activities and accounting and a willingness to study the information in the financial statements with reasonable diligence;
2. Understand that financial statements are prepared, presented and audited to levels of materiality;
3. Recognize the uncertainties inherent in the measurement of amounts based on the use of estimates, judgment and the consideration of future events; and
4. Make reasonable economic decisions on the basis of the information in the financial statements

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.

In planning the audit, the auditor makes judgments about the size of misstatements that will be considered material. These judgments provide a basis for :

1. Determining the nature, timing and extent of risk assessment procedures;
2. Identifying and assessing the risks of material misstatements; and
3. Determining the nature, timing and extent of further audit procedures

The materiality determined when planning the audit does not necessarily establish an amount below which uncorrected misstatements, individually or in the aggregate, will always be evaluated as immaterial. The circumstances related to some misstatements may cause the auditor to evaluate them as material even if they are below materiality. Although it is not practicable to design audit procedures to detect misstatements that could be material solely because of their nature, the auditor consider not only the size but also the nature of uncorrected misstatements, and the particular circumstances of their occurrence, when evaluating their effect on the financial statements