Materiality

KEY POINTS – p.409

We know come to ‘materiality’, the expression of the

relative significance or importance of a particular
matter in the context of the financial statements as
a whole.
A matter is material if its omission or misstatement
would reasonably influence the decisions of a user
of the financial statements.

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 KEY POINTS – p.410

Users of financial statements may be sophisticated

and knowledgeable, or unsophisticated and naive.

Auditors therefore need to have a way of measuring

when misstatements or omissions are material
enough to cause financial statements not to give a
true and fair view – a judgemental area.

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 KEY POINTS – p.411

Auditors often direct attention to the profit before tax

figure when determining materiality level, setting
materiality levels in terms of a percentage of the
figure, often on an average basis over a number of
years.
Auditors look at nature and extent of ‘errors’ and
company context before taking a final decision
about materiality.

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 KEY POINTS – p.411 CONT'D

The materiality level set and the amount of evidence

auditors need are related; the lower the materiality
level the greater the quantity of evidence required.
Auditors will set materiality levels for other figures
too, including turnover, total assets and net assets
and, in practice, normally calculate materiality levels
based on several criteria and then decide on
appropriate materiality levels for different aspects of
the audit.

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 ACTIVITY 11.4

We have indicated above that auditors may

consider using a certain percentage of profit as
the materiality level. Suggest other matters
relating to profit that auditors may consider when
setting materiality levels.

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 KEY POINTS – pp.412–413

Auditors may give greater emphasis to testing for

overstatements rather than understatements and
may consider other matters relating to profit:
• trend in profits;
• effect of profit figure on ratios;
• external influences;
• poor performance and difficulties in raising
finance.

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 KEY POINTS – p.413

Auditors set materiality levels at the audit planning

stage to put audit risk into context, as there is a
strong relationship between risk and materiality.
Most risks relate to specific financial statement
headings and auditors assign a materiality level to
components of the financial statements.

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 ACTIVITY 11.5

What factors do you think are likely to influence

auditors when determining a materiality level for
components of the financial statement?

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 KEY POINTS – p.414

Factors likely to influence determination of the

materiality level for components include:
• importance of the heading;
• nature of item;
• auditors’ past experience; and
• trend in the account balance.

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 KEY POINTS – p.415

Setting individual materiality levels is important

because it influences the nature and scope of work
on individual account balances. Auditors record the
materiality levels and reasons therefor.
During the audit auditors may change their views
about appropriate materiality levels because of:
(1) changes to draft accounts;
(2) evidence gathered during audit testing.

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 KEY POINTS – p.416

The effect of any misstatements found are evaluated

and an estimate made of the amount of potential
errors in the components of the financial statements
and in the financial statements taken as a whole.
If auditors find their estimate of the misstatements is
less than the materiality levels set, they can conclude
that the financial statements are not materially
misstated.

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 ACTIVITY 11.6

Earlier we said that auditors would have to

consider the nature of the misstatements found.
Suggest matters relating to such nature the
auditors may wish to consider when performing
their evaluation of the misstatements.

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 KEY POINTS – p.416–417

Auditors will consider the nature of ‘errors’ and,

if management decide not to adjust, the auditors
should determine the reasons. If auditors believe
‘errors’ may be material they extend the scope of
audit tests.
In evaluating misstatements auditors consider the
following features:

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 KEY POINTS – p.417

• size and incidence;

• whether ‘errors’ exhibit a pattern;
• whether ‘errors’ relate to factual matters or
matters of opinion;
• whether the ‘errors’ relate to illegal matters;
• whether there is suspicion of fraud;
• whether similar ‘errors’ were discovered in
previous year;
• whether misstatements affect only balance sheet
items or the profit and loss account too.

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 KEY POINTS – p.418

Qualitative issues to be considered are:

(a) whether the item is required to be disclosed;
(b) whether accounting policies are improperly
disclosed; and
(c) where there is improper classification.

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 CHAPTER SUMMARY

This chapter has concerned itself with:

• The twin concepts of audit sampling and materiality;
• How audit sampling may be classified as non-
statistical sampling and statistical sampling;
• Those factors that determine sample size;
• Attribute sampling;
• Monetary unit sampling;

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 CHAPTER SUMMARY CONT'D

• How materiality in financial statements is related

to the use made of financial statements by users;
• Those factors, both quantitative and qualitative,
which influence auditors when arriving at a
materiality level;
• How auditors use materiality at the planning
stage, during the audit and at the evaluation stage
of the audit.

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 FURTHER READING

Draft Audit Brief, Audit Sampling, published by the

Auditing Practices Committee in 1987.
Carpenter, B. and Dirsmith, M. (1993) ‘Sampling
and the abstraction of knowledge in the auditing
profession: An extended institutional theory
perspective’, Accounting, Organizations and
Society, 18(1): 41–63.

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 FURTHER READING CONT'D

Iskandar, T.M. and Iselin, E.R. (1999) ‘A review of

materiality research’, Accounting Forum, 23(3):
209–39.
Power, M.K. (1992) ‘From commonsense to
expertise: Reflections on the prehistory of audit
sampling’, Accounting, Organizations and Society,
17(1): 37–62.

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