What is Audit Materiality?

Definition,
Characteristics, Types And More

Definition
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.

The concept of materiality is applied by the auditor both in planning

and performing the audit, and in evaluating the effect of identified
misstatements on the audit and of uncorrected misstatements, if any,
on the financial statements and in forming the opinion in the auditor’s
report

ISA 320, paragraph 10, requires that "planning materiality" be set

prior to the commencement of detailed testing. ISA 320, paragraph 12
requires that materiality be revised as the audit progresses, if (and
only if) information is revealed that, if known at the onset of the audit,
would have caused the auditor to set a lower materiality. In practice,
materiality is re-assessed at least once, during the conclusion of the
audit, prior to the issuing of the audit report. This materiality is
referred to as "final materiality".
ISA 320, paragraph 11, requires the auditor to set "performance
materiality". ISA 320, paragraph 9, defines performance materiality as
an amount or amounts that is less than the materiality for the
financial statements as a whole ("overall materiality"). It includes
materiality that is applied to particular transactions, account balances
or disclosures. Paragraph 9 also states that the purpose of setting
performance materiality is to reduce the risk that the aggregate total
of uncorrected misstatements could be material to the financial
statements.

In terms of ISA 320, paragraph A1, a relationship exists between audit

risk and materiality. This relationship is inverse. The higher the audit
risk, the lower the materiality will be set. The lower the audit risk, the
higher the materiality will be set.

In terms of the Conceptual Framework (see "materiality in

accounting" above), materiality also has a qualitative aspect. This
means that, even if a misstatement is not material in "Dollar" (or other
denomination) terms, it may still be material because of its nature. An
example is if a disclosure is omitted from the financial statements.

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.

Conclusion

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.