ISA 320 deals with the materiality concept and guides the auditor that how to determine the materiality based on the financial statements and how to set the materiality and revise it during the audit if required.
1 ISA 320 deals with and guides the auditor that how to determine materiality and how and when to revise it as the audit progresses.
2 The materiality concept can be different for different types of companies and it refers to the fact that an amount could be material for any company of which its omissions and negligence could significantly influence the economic decision of the users of the financial statements.
3 The decision and determination of the materiality are purely based on the professional judgment of the auditor and to be set as per the nature of the business and its environment.
4 The auditor shall revise the materiality figure as and when the audit progress and it shall be revised when the auditor obtains new information which is significantly different from the information obtained at the start of an audit about any subject matter.
5 The performance materiality is the amount that is set below the materiality (say 75% of the whole materiality) amount and it is used to see that the misstatements either individually or aggregated with other misstatements do not exceed the amount of the materiality amount and if so the auditor shall consider an appropriate course of action.
UNDERSTANDING MATERIALITY CONCEPT
Materiality refers to the fact that the amount involved in the misstatement either individually or aggregated with other misstated amounts could be of such a nature that its ignorance or reporting could significantly influence the economic decision of the users of the financial statements.
The materiality could be different for different companies as 10,000 USD could be material to a small or medium-size company but 10 million USD amount could be immaterial to another company. Materiality is something that could shake the financial position of a company if such an amount goes misstated or neglected while reporting on the financial statements.
The determination of the materiality mainly depends upon the professional judgment of an auditor and for this purpose, the auditor has to consider the following factors:
=> The knowledge of business activities and their environment, this knowledge can be obtained by looking into the previous year’s financials and by discussing with the senior management of the business entity.
=>Assess the control activities and also the inherent risks that could exist in the entity’s internal controls.
=>The auditor usually plans the materiality during the planning stage of an audit and during the performing of an audit. It is important to note that the concept of materiality does not always apply to numerical figures of the financial statements but to other misstatements as well. For example, if a company defaults in paying any government fee could be material even though the amount involves is less because such delays in paying government dues could lead to heavy fines and penalties and even closure of a business entity in worst scenarios for non-compliance issues.
MATERIALITY IN DURING THE PLANNING STAGE OF AN AUDIT
The concept of materiality involves the professional judgment of an auditor and the auditor usually considers a specific percentage to be multiplied with a specific account head of either statement of financial position or the statement of profit or loss and other comprehensive income. For example, the auditor needs to calculate the materiality so he might think to take 2% of the total non-current asset as materiality (in case of vehicle operating business or in case of heavy transportation business). Similarly, an auditor might like to take 1% of the total sales revenue as materiality (in the case of a service provider company where sales revenue is often the largest amount in financial than assets).
Again, the auditor shall use his professional judgment in the determination of materiality while using his professional knowledge and based on the nature and activities of the business entity.
The auditor shall consider the misstatement in the presentation and disclosures and evaluate whether such misstatements are above or below the materiality level. Notes and disclosures are an integral part of the financial statements and the auditor shall pay special attention to such to ensure that the notes and disclosures in the financial statements are as per the requirements of the international accounting standards.
The performance materiality is the materiality that is set below the amount of materiality and it is set by the auditor to check that the individual or aggregated misstatements do not exceed the amount of the materiality as a whole. However, the auditor shall set the performance materiality for particular classes of transactions and account balances. It all depends upon the professional judgment of the auditor that how he decides to set the materiality and performance materiality in accordance with the given situation of the business.
REVISION OF MATERIALITY
As discussed earlier in this article that the materiality set by an auditor shall not be fixed and it is to be revised as and when the audit progress and the auditor obtains new information which is changed from the prior information that he gained at the start of the audit.
The auditor needs to maintain the following types of audit documentation as a minimum under the ISA 320:
=>The materiality of the financial statements as a whole
=>The performance materiality of the financial statements
=>The revision of the materiality along with a sufficient explanation of the reason for the revision
=>The materiality for the particular class of transaction and other account balances and disclosures