Materiality & Performance Materiality (ISA-320)
Auditors apply the concept of materiality in planning and performing an audit of financial statements. It is explained here how materiality is applied in evaluating the effect of identified misstatements on the audit and the effect of uncorrected misstatements, if any, on the financial statements.
Materiality in the Context of an Audit
FRF often discuss the concept of materiality in the context of the preparation and fair presentation of FS. Although FRF may discuss materiality in different terms, they generally explain that:
▪ Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users made on the basis of the financial statements.
Materiality in Planning Audit
In planning the audit, the auditor makes judgments about the size of misstatements that will be considered material. These judgments provide a basis for:
▪ determining the nature and extent of risk assessment procedures;
▪ identifying and assessing the risks of material misstatement; and
▪ determining the nature, timing, and extent of further audit procedures.
Materiality in Performing Audit (Revision as the Audit Progresses)
The auditor should revise materiality for the FS as a whole (and, if applicable, the materiality level or levels for particular classes of transactions, account balances, or disclosures) in the event of becoming aware of information during the audit that would have caused the auditor to have determined a different amount (or amounts) initially. The auditor obtains reasonable assurance by obtaining sufficient appropriate audit evidence to reduce audit risk to an acceptably low level.
Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. (ISA-200)
Audit risk is a function of the risks of material misstatement and detection risk. Materiality and audit risk are considered throughout the audit.
Audit Risk = Detection Risk x Inherent Risk x Control Risk
Calculation of Materiality
Calculating materiality is a matter of auditor’s judgment. Materiality is calculated as a percentage of one of:
▪ Profit before tax;
▪ Revenue; and
▪ Total assets.
But ISAs also quantify the calculation of materiality as:
▪ 5% of profit before tax;
▪ 1% of revenue; and
▪ 1-2% of total assets.