ICPAK AUDIT MANUAL 11. MATERIALITY (INCORPORATING ISA 320) 11.1. Definition Materiality is defined 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. Material 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" The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework. The assessment of materiality assists: > As an aid, together with risk assessment, to establishing the nature, timing and extent of audit procedures to reduce the audit risk to an acceptably low level. > To decide what items to examine and whether to use sampling and substantive analytical procedures in relation to classes of transactions, account balances, and disclosures. > In deciding which transactions are to be tested. In evaluating potential and actual quantitative misstatements. General Considerations in Setting Materiality Levels In designing the audit plan, the engagement team needs to establish an acceptable materiality level so as to detect quantitative (based on the amount) material misstatements. However, the engagement team should be mindful that qualitative misstatements (based on the nature) need also to be considered. The following should be considered in setting materiality levels: > The possibility of quantitative misstatements of relatively small amounts that, cumulatively, could have a material effect on the financial statements e.g. errors in month end procedures could be material if that error is repeated each month. > In addition to quantitative misstatements, qualitative misstatements may materially affect the financial statements. Such misstatements and the audit approach are covered in other chapters of the manual. Examples of qualitative misstatements include: . Inadequate or improper description of an accounting policy when it is likely that a user of the financial statements would be misled by the description. . Failure to disclose the breach of regulatory requirements when it is likely that the consequent imposition of regulatory restrictions will significantly impair operating capability. > Some areas, principally those where "sensitive" disclosures are required in the financial statements e.g. related party transactions should always be regarded as material at the planning stage. 1 Materiality may be influenced by classes of transactions, account balances, and disclosures and their relationships, resulting in different materiality levels depending on the aspect of the financial statements being considered. > The assessment of materiality and risk may be different at the planning level from that at the completion stage either due to changes in circumstances or because of change in the auditor's 11. Materiality Version 1 - 9th October 2006 1 of 7
ICPAK AUDIT MANUAL knowledge as a result of performing audit procedures. In some cases, during planning, materiality may intentionally be set