3 How materiality is determined?
Usually accounting framework used to prepare financial statements helps in determining materiality however, as determination of materiality involves use of judgment therefore following factors must be kept in mind:
- What is material is circumstantial and nature and size of misstatements also affect the consideration.
- As audit relates to general purpose financial statements meant to fulfill general information needs of users the same is kept in mind while considering materiality level for audit purposes which may not cater specific needs of users.
In short relevant accounting framework (applicable standards and laws) may provide guidance to auditor regarding materiality in the absence of which above two factors are there as a frame of reference.
Although auditor considers the guidance provided by applicable financial reporting framework and laws however, it is left on the auditor to decide what is material which he determines by applying his professional judgment.
Although general nature of needs of users of financial statements is considered in determining materiality level however users are assumed to have:
- Reasonable understanding of accounting and how business works.
- User is ready to put in the effort required to get the benefit of information embedded in the financial statements
- Understanding of existence of inherent limitations of accounting
- Knowledge that financial statements are meant to serve general needs of information and can help in economic decisions that are reasonable keeping general nature of information in mind
3.1 Does “immaterial” equate to “not material”?
Materiality level helps auditor to catch the misstatements easily. It acts as threshold which must not be breached. However, it does not mean that if misstatement is immaterial, individually or in combination with others, then it cannot be evaluated by the auditor. Auditor may decide to evaluate misstatements less than material.
The reason is auditor not only obtains reasonable assurance that financial statements are free from material misstatements but also ensures that effect of uncorrected misstatements do not amount to materiality level.
However, only the nature of misstatement is not an appropriate guide to select a misstatement for evaluation. Auditor should size of the misstatement as well with the nature of misstatement to properly evaluate its effect.