Concept of Materiality

1
Concept of Materiality

• Session OverviewConcept of materiality
• Materiality Judgment
• Materiality Guidelines
• Steps in determining materiality level and

2
LEARNING OBJECTIVES

• ? Identify the users and the uses
• ? Determine appropriate materiality level and
• ? Describe the factors
• affecting materiality
• level.

3
MATERIALITY AND AUDIT OPINION
Implies
There is reasonable assurance
In my opinion, these financial statements
Implies
Present fairly
Not materially misstated
4
MATERIALITY AND AUDIT OPINION

• I am x confident that the financial
  statements are correct within Rs. y
• x is the overall level of
• assurance
• Rs. y is the materiality amount

5
DEFINITION OF MATERIALITY

• The magnitude or nature of a misstatement
  (including an omission) of financial information
  either individually or in the aggregate that, in
  the light of surrounding circumstances, makes it
  probable that the judgement of a reasonable
  person relying on the information would have been
  influenced or his decision affected, as a result
  of the misstatement.
• 
  --IFAC Handbook

6
CONSIDERATIONS IN UNDERSTANDING MATERIALITY

• Determined from users point of view
• Relates to maximum possible misstatements
• The misstatement includes all types of errors,
  frauds and other irregularities
• Not related to the amount used by management
• Auditor is concerned with the judgements of those
  
• who have "a reasonable knowledge of
• business and economic activities
• Determined without reference to audit assurance.

7
MATERIALITY AT DIFFERENT STAGES

• Planning
• Decides what items to examine and whether
• to use sampling techniques
• Calculate planning materiality.
• Execution
• Sample size on materiality
• Drives additional procedures.
• Reporting
• Accumulated errors compared to materiality
  limit.

8
FACTORS AFFECTING MATERIALITY

• Three Main Factors
• Amount of the item
• Nature of the item
• Context in which the item occurs
• Other Factors
• Size of the entity,
• Nature of the misstatement,
• Entity-related factors,
• Environmental factors,
• Uncertainty,
• Cost-benefit considerations, and
• Characteristic of Accounting System Policies.

9
MATERIALITY GUIDELINE

• - Cash basis accounting (gross
  expenditure/receipts)
• Classification of account
  Materiality as age
  Very sensitive
  1/2
• Sensitive
  1/2 - 2
• Not sensitive
  2
• - Accruals accounting
• Base figure Very
  sensitive Sensitive Not sensitive
  
• Normal net surplus 5
  5 - 10 10
• Average Operating Income 5
  5 - 10 10
• Gross income/expenditure 1/2
  1/2 - 2 2
• Total assets
  1/2 1/2 - 1 1
• Working Capital 1
  1 - 2 2
• Equity
  1 1 - 2 2

10
STEPS IN DETERMINING MATERIALITY LEVEL

• Identify probable users
• Identify important information
• Review materiality guideline
• Determine sensitivity of accounts
• Determine highest of base amount
• Multiply the by base
• amount and select
• lowest product.

11
Tolerable Misstatements/Errors
A judgment of the maximum monetary misstatements
that may exist in an account balance or a class
of transactions without causing the financial
statements to be materially misstated