Auditing is the process of inspecting account books and financial reports of an individual or organization to ensure they portray the true and fair opinion of the undertakings.
It is also used to assess the consequence of known misstatements on the audit and the consequence of misstatements that weren’t corrected, if any, on the financial reports; and in instituting the view in the auditor’s report.
Information provided by firms is said to be material if its omission from the financial reports or making errors when recording it may influence financial statements users’ decisions.
In this article, we will discuss the performance materiality and tolerable errors in the auditing context.
The framework of financial reporting generally explains materiality as
- Misstatements that could influence in a significant way the decisions made by the users in relation to the financial reports.
- Materiality judgments are made after consideration of the adjacent environment and can be swayed by the nature of the misstatement or how big the misstatement is.
- Matters that are material to financial reports users are from the contemplation of the mutual financial information wants of users when making judgments. The needs of specific users of financial information may vary widely and the effects misstatements on these users are not considered.
- The users have knowledge of business matters and are eager to study financial statements information with sensible diligence.
- The users make rational financial decisions using the information provided by the financial reports.
- The users acknowledge the risks inherent in amounts of measurements based on estimates and forecasts.
- The users understand that financial reports are audited to the levels of materiality after their preparation and presentation.
In the planning phase of the audit, the auditor makes rulings about the magnitude of misstatements that will be well-thought-out as material. These rulings provide a foundation for:
- Determining the assessment and degree of risk valuation procedures;
- Detecting and evaluating the material misstatement risks.
- Determining the methods and extent of further audit procedures.
Overall materiality is the maximum volume of information that, if omitted, misstated, or not disclosed, then it is likely to influence the financial decisions of financial report users or the release of answerability by the management or those governing the firm.
It is assessed as part of the audit planning and returned to and reviewed all the way through the process of auditing. It is commonly calculated by using a percentage to a selected benchmark.
In determining overall materiality the following should be considered;
- The major users of the financial statements
- Information important in making financial decisions
- Qualitative and quantitative factors that may influence the requirements of financial reporting users about materiality.
Performance materiality is the amounts established by the auditor below the normal materiality of financial reports to decrease the probability that the aggregate of uncorrected and undetectable misstatements exceeds the level of financial reports as a whole.
It is generally the amount set below the overall materiality. It can also refer to the amount established by the auditor below the materiality levels of certain transaction classes. Balances of accounts or revelations.
In setting the performance materiality the auditor may consider factors such as; the risks within the firm, the environment controlled by the firm, and the misstatements expectations.
Performance materiality can impact an auditor’s work in the following ways;
- Deciding the areas and accounts of financial reports to focus on. (scoping)
- Determining sample sizes that are developed statistically.
- Determining if investigations should be done on variances of analytical reviews
- Assessing material misstatement risks.
Performance materiality level chosen is due to proficient judgment, and is influenced by the understanding of the auditor about a client, including the natures and amounts of misstatements established during preceding audits of the client; these influence the expectations of the auditor concerning misstatements that might be existing in the present period.
The performance materiality level can be established at different levels for the various accounts.
Tolerable error is the maximum error the auditor is willing to accept in a population. Tolerable error is an idea that allows the auditor to put on planning materiality at the level of the individual account balance. The idea is used to:
- Determine the significance of accounts
- Develop prospects at the anticipated accuracy level when doing analytics.
- Determine the degree of testing when using an illustrative sample or testing various important items
- Ensure fairness of the presentation when auditing a firm
When coming up with the tolerable error, the auditor should contemplate the risk of control level that was both assessed and planned and the desired assurance degree from the sample.
Reviewed by Sinra