Materiality can be regarded as a concept in auditing and accounting, which relates to the importance and significance of an amount, transaction or respective discrepancy that might occur in the financial statements.
It stands to be one of the most important objectives of the audit arrangements since it is the auditors’ responsibility to base his opinion on the judgment regarding if financial statements are prepared, in material aspects, and include all the relevant disclosures that should be included.
Characteristics of Materiality
Given the fact that materiality is the first and foremost pillar of financial reporting, it can be seen that it is defined in ISA 320 as a separate standard.
In this particular standard, the overall characteristics of materiality are described, which include the following:
- Misstatements are considered to be material if they are likely to influence the decisions of the end-users of the financial statements
- Judgments about materiality are subsequently based on external surrounding circumstances, which mainly include the size and nature of the subsequent misstatement
- Lastly, judgments are also based on users’ common needs as a group
Types of Materiality
Audit Materiality can be broadly seen as Qualitative as well as Quantitative.
As far as qualitative materiality is concerned, it can be seen that it is something that is fundamentally important, because it reflects on discrepancies that exist within the financial statements, and can have an alternating impact on the decision-making process.
For example, a company might choose to amortize an asset for 25 years, whereas the useful life is only stated to be 10 years, in the disclosures presented.
Additionally, any discrepancy about contingent liabilities, or related party transactions can also make an impact on the overall state of affairs.
On the other hand, as far as quantitative materiality is concerned, it is basically numerical misstatements, or discrepancies, that would have a significant impact on the end decision-making tool.
For example, it can be seen that a line item of irrecoverable amounts (bad debts) was not disclosed in the financial statements, whereas this item, would otherwise have had a significant impact on the overall financial statements.
Why is Audit Materiality Important?
Audit Materiality is a very important concept that bases on both, quantitative as well as qualitative aspects.
This really helps in the end-users of the financial statements to be able to use it as a tool for economic decision-making tools, as they would have sufficient knowledge pertaining to contingent liabilities, related party transactions, and any other subsequent change in accounting policy that they should be aware of.
Therefore, all these factors play a very important role in determining the overall extent to which users can base their judgments on.
Audit Materiality forms the very basis on which the auditor is able to formulate an opinion regarding the overall level of assurance that can be provided to the end-user.
This is because, they have to report whether financial statements are free from material misstatements or not, and therefore, this is the main crux around which their work revolves.
Therefore, it can be seen that Audit Materiality is a very important concept, that proves to be the basis of the scope of audit work and the ultimate audit opinion that is presented for the shareholders.
If this concept is not taken into account, then the overall point of audit assurance becomes redundant.