Materiality
Materiality
Needs information
for decision
Reality
Active
Assets
Passive
Equity
Debts
Audit
Materiality
Accounting
Materiality
Accountant
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Auditor
Materiality
Needs information
for decisions
“Information is material if its omission or
misstatement could influence the
economic decisions of users taken on the
basis of the financial statements.
Materiality depends on the size of the
item or of the error judged in the
particular circumstances of its omission
or misstatement.
Thus, materiality provides a threshold, or
cutoff point, rather than being a
qualitative characteristic (which
information must have to be useful).”
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Materiality
Users
Economic Decision
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Unknown to the auditors?
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Decision Model
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„The public“ in general
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Specific needs (Banks, Creditors, etc)
Made on the basis of financial
statements
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As investor are providers of risk
capital to the entity, the provision of
financial statements that meet their
needs will also meet most of the
needs of other users of those financial
statements.
This is not applicable in practice
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Dilemma
Materiality
Audit
Materialtity
The audit of financial statements aims to enable the auditor to form an opinion
as to whether or not the financial statements are prepared, in all material
respects, in accordance with an applicable financial reporting framework. The
assessment of what is material is a matter of professional judgment
è Therefore the auditor has to assess what level of error would
influence the users of the financial statements (i.e.: stakeholders).
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Understand the Conditions that Determine Materiality:
Planning Materiality (PM)
Materiality is thus the maximum amount by which the auditor believes the financial
statements could be misstated and still considers acceptable given the purpose of the
financial statements. It is the degree of inaccuracy or imprecision that is still
considered acceptable. The auditor tries to achieve a reasonable degree of certainty
whereby the errors in total do not exceed this determined materiality level.
Materiality is used to design the audit, such that the auditor can obtain reasonable
assurance that any error, material in size or nature, will be identified. The lower the
materiality… the more costly the audit.
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Understand the Conditions that Determine Materiality:
Tolerable Error (TE)
Tolerable error is a concept that enables the auditor to apply planning materiality at
the individual account balance level. The concept is used to:
►
determine which accounts or group of accounts are significant
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develop expectations at the desired precision level when performing analytics
►
determine the extent of testing when using a representative sample or testing
various key items
►
conclude on the fairness of the presentation
When auditing an individual account balance, it is not appropriate to plan the tests
merely to detect errors that would aggregate to the planning materiality. To do so
would leave no margin for the audit differences in other accounts or for potential
undetected audit differences. Therefore, the tolerable error is established at an
amount less than planning materiality
Tolerable error is set so that the probability is remote that the total of likely
misstatements and undetected misstatement in all accounts will exceed planning
materiality.
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Understand the Conditions that Determine Materiality:
Nominal Amount (NA)
The nominal amount selected is an amount at which any adjustments
below it, individually or in the aggregate, would be immaterial to the
financial statements being audited and is an amount consistent with
the entity’s expectations. We set the nominal amount at a small
percentage (1% to 5%) of Planning Materiality.
Audit Differences
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Understand the Conditions that Determine
Materiality (PM, TE, SAD)
Planning materiality
(PM)
Financial
Statements
Tolerable Error
(TE); approx. 50%
PM
Accounts
Nominal Amount
approx. 5% PM
Journal Entry
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How to resolve the dilemma?
How to resolve the dilemma?
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Definition is not applicable in practice.
Professional standards give no additional guidance.
Concept is nevertheless crucial for the auditor.
Rules of thumb commonly used in practice:
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5 to 10% of net income before taxes
5 to 10% of current assets
5 to 10% of current liabilities
0.5 to 2% of total assets
0.5 to 2% of total revenues
1 to 5% of total equity
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