ISA 320 defines information as material if ‘its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.’
Material items could be large transactions or significant events.
Materiality is important to the auditor because if a material item is incorrect, the financial statements will not show a ‘true and fair view.’
The auditor will decide materiality levels and design their audit procedures to ensure that the risk of material misstatements is reduced to an acceptable level.
Generally, materiality will be set with reference to the financial statements such as:
0.5 – 1% of turnover
5 – 10% of profits reported
1 – 2 % of gross assets
Judgement will be used by the auditor in charge and will depend on the type of business and the risks it faces.
The relative size of the item
This might be something that's low in value but could still affect users' decisions e.g.. Directors wages
This is when the auditor accepts the error
For example finding one error out of 100 tested, might be ignored
The tolerable level will be decided at planning stage
This is lower than normal materiality
The idea is that this will try to prevent all those small, undetected errors do not aggregate to become material
There are now 2 standards to consider..
ISA 320 Audit Materiality
ISA 450 Evaluation of Misstatements Identified During the Audit
As we know, materiality is calculated at the planning stage
But it might not stay at that amount - oh no baby
Things happen that make the auditor change the level
Such things are often immaterial in quantity but material by their nature
The company you are auditing makes a $5,000 profit.
The materiality is set at $10,000
You notice that an invoice for $6,000 has been incorrectly placed into next year.
This would be material as it changes the look of the whole accounts (changing a profit into loss)
The new standard recognises that there could well be instances where certain classes of transactions, account balances or disclosures might be affected by misstatements which are less than the materiality level for the financial statements as a whole, but which may well influence the decisions of the user of those financial statements regardless of the fact they are below materiality – this is where performance materiality is to be applied.
Specifically, the clarified ISA 320 suggests performance materiality be applied to areas such as related party transactions and directors’ remuneration.