Which one of the below statements best describes the concept of materiality?

Applying the materiality requirements in International Standards on Auditing (ISAs) can be challenging. As highlighted in inspection findings, reviews and from experience in practice, it’s an area where improvement could be made.

Download the full guidance

Materiality in the audit of financial statements.

Download the guide

Published jointly by Audit and Assurance Faculty and International Standards (formerly International Accounting, Auditing and Ethics (IAAE)) this guide takes a practical look at the ISA requirements on materiality, highlighting the challenges and providing practical illustrations.

What is materiality?

Materiality is first and foremost a financial reporting, rather than auditing, concept. It isn’t defined in ISA 320 Materiality in planning and performing an audit but the ISA highlights the following key characteristics:

  • Misstatements are considered to be material if they could influence the decisions of users of the financial statements
  • Judgements about materiality are based on surrounding circumstances, including the size and nature of the misstatement
  • Judgements are based on the users’ common needs as a group.

Why is materiality important?

As the basis for the auditor’s opinion, ISAs require auditors to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement. The concept of materiality is therefore fundamental to the audit. It is applied by auditors at the planning stage, and when performing the audit and evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements.

Who is the guide aimed at and how does it help?

This guidance is aimed at auditors in all jurisdictions where ISAs are applied. It is intended to be of particular help to smaller audit firms. The guidance takes a look at the ISA requirements on materiality and uses practical illustrations to highlight good practice, key challenges and common pitfalls. It has been put together by a working group of experienced auditors. It is intended to help audit firms better understand, and appropriately apply, materiality when planning and performing audits and evaluating misstatements.

Key themes

Determining materiality

While not set in stone, typically there are three key steps to determining overall materiality (materiality for the financial statements as a whole):

  • Choosing a benchmark
  • Determining a level of this benchmark
  • Justifying the choices.

The guide looks at these steps and the potential challenges that arise. It provides guidance on when it might be appropriate to set specific levels of materiality for individual balances, classes of transactions or disclosures, what to do with short/long periods of account or situations where materiality might need to be reassessed. The guide also explains what performance materiality is, providing guidance on how it might be determined.

Applying materiality to the evaluation of identified misstatements

This section of the guide looks at the practical issues around:

  • Accumulating misstatements during the audit;
  • Categorising misstatements according to their nature;
  • Assessing the materiality of misstatements; and
  • Considering the impact of misstatements on the audit.

Materiality in group audits

Just as auditors would for a single entity audit, group auditors must use judgement to determine group materiality and group performance materiality. However, a key difference is that group auditors also have to determine levels of component materiality for components that have audits or reviews for the purposes of the group audit. The guide takes auditors through practical illustrations covering how to determine component materiality and component performance materiality, a clearly trivial threshold, component materiality for associates and joint ventures and the effects of changes in group materiality.

Communications with management and those charged with governance

There will be a number of communications with management and those charged with governance during the audit in relation to materiality and the misstatements identified and the guide focuses on what might need to be communicated at the planning stage, as the audit progresses and in the final stages of the audit.

Documentation

Auditors need to document materiality, the evaluation of misstatements and the rational for both. This section of the guide examines the documentation requirements and provides practical illustrations.

To comment on this publication or find out more about the issues raised contact Louise Sharp (Manager, International Standards).

Individual subscriptions and access to Questia are no longer available. We apologize for any inconvenience and are here to help you find similar resources.

As the world of education changes, Gale continues to adapt to the needs of customers and users. We offer many other periodical resources and databases that have been recently enhanced to make discovery faster and easier for everyone.

What are the 3 types of materiality?

Overall Materiality. When establishing the overall audit strategy, the auditor determines materiality for the financial statements as a whole. ... .
Performance Materiality. ... .
Specific Materiality. ... .
Specific Performance Materiality..

What is your understanding of materiality concept?

Materiality is an accounting principle which states that all items that are reasonably likely to impact investors' decision-making must be recorded or reported in detail in a business's financial statements using GAAP standards.

What is the concept of materiality in auditing?

In auditing, materiality means not just a quantified amount, but the effect that amount will have in various contexts. During the audit planning process the auditor decides what the level of materiality will be, taking into account the entirety of the financial statements to be audited.

What is the main purpose of the materiality concept in financial accounting?

Materiality concept in accounting refers to the concept that all the material items should be reported properly in the financial statements. Material items are considered as those items whose inclusion or exclusion results in significant changes in the decision making for the users of business information.