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Materiality Materiality is defined in the Financial Reporting Standard Councils Framework for the Preparation and Presentation of Financial

Statements, in the following terms: Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.

Concept of Materiality y the largest amount of misstatement that the auditor could tolerate in the financial statements, or y the smallest aggregate amount that could misstate the financial statements Materiality is a matter of professional judgment and necessarily involves quantitative factors (amount of the item in relation to the financial statement) and qualitative factors (the nature of misstatement)

Importance of Materiality in planning an Audit The auditor should make preliminary estimate of materiality to determine the amount of evidence to accumulate. There is an inverse relationship between materiality and evidence. This means, more evidence will be required for a low peso amount of materiality than for a high peso materiality. Uses of Materiality According to PSA 320, Materiality should be considered by the auditor: y In the Planning Stage, to determine the scope of audit procedures; and y In the Completion Phase of the audit, to evaluate the effect of misstatement of on the financial statement.

Using Materiality Levels The following steps may be use as a guide when using materiality levels. Step 1 and 2 are performed in the Planning Phase while the step 3 is performed in the completion phase of the audit.

Step 1: Determine the Overall Materiality Financial Statement Level The auditor should determine the amount of misstatement that could be material to the financial statement taken as a whole. A common method of estimating materiality at the financial statement is to simply multiply a statement base (total asset, sales, or net income) by a certain percentage. Step 2: Determine the tolerable misstatement Account Balance Level Once the overall materiality is establish, the auditor determines the materiality at the account balance level. This is done by allocating the overall materiality of financial statement account balances. This allows the auditor to determine the audit procedures that will be applied to specific accounts. The allocated materiality to an account is called tolerable misstatement for that account. The professional standards do not provide specific guidelines as to how the allocation should be done. The process is highly subjective and requires the exercise of great deal of judgment by the auditor. Step 3: Compare the aggregate amount of uncorrected misstatements with the overall materiality After performing audit procedures, the auditor will have to compare the aggregate uncorrected misstatements with the overall materiality (preliminary estimate of materiality or revised materiality level) to determine whether or not the financial statements are materially misstated. Bases that can be used to determine the materiality level Since audit planning is often performed before the year-end, annual financial statements are usually not available. As a result, the auditor uses alternative bases to compare for the materiality levels, such as: y Annualized interim financial statements y Prior years financial statement y Budgeted financial statements of the current year