What is material and what is not?

| How to determine materiality? | Concept of materiality |

Before, I start this article I want to state that this article might contain a bit of jargons.

But, I know many of the readers are going to be CA aspirants or Qualified CA s, so I can utilize this opportunity and be technical.

(Lucky Me!)

Let’s get started~~

Concept

Material is something which has a significance, an importance in a particular matter.

Suppose, you are walking down a lane, walking on your left (in India) and on the footpath are significant for your safe walk, thus, becoming material.

In the world of Auditing and Accounting, material is something which in individual or in aggregate is expected to influence the economic decisions of the users based on the financial statements.

It can also be something which plays a major role regarding its nature, size, the circumstances surrounding it, etc. This all is based on the professional judgement of the auditor.

The financial reporting frameworks do provide the bases for determination of materiality but if not, then the basic principles stated above can be used.

Types of materiality

1)  Planning Materiality:

While establishing the overall audit strategy at the planning stage, the auditor shall determine the overall materiality for the financial statements as a whole.

This is also termed as Planning Materiality.

Planning materiality is set using an appropriate benchmark. This benchmark is selected keeping in mind the common financial needs of the users of financial statements.

[For example, if the audit is being conducted of a charitable institution then selecting revenue or profit is not going to be a good benchmark option.

For such institutions the Cost plays a major role (Expenses-Revenue) to determine the materiality levels.]

On the benchmark so selected the auditor applies a certain %, the resultant becomes our planning materiality.

Suppose a company has a turnover of 500cr (Benchmark in this case), the % decided by the auditor is say, 5%. The planning materiality will be (500cr*5% =) 25cr.

<Remember: We haven’t considered any risks while deciding planning materiality because it is being decided at an initial stage of the audit.>

2)  Performance Materiality:

Do we need to consider another level of materiality, wouldn’t just one level be okay?

No, it will not be feasible for the auditor to do so.

Why?

There might be a high chance that the aggregate of immaterial misstatements can exceed the overall materiality level (Planning materiality).

OR

In a particular circumstance, one or more transactions/account balances/disclosures for which misstatement of amounts lesser than the overall materiality level can be expected to influence the economic decision of the user of financial statements.

To safeguard this risk the auditor sets another level, termed as Performance Materiality

This is calculated by applying a certain % to the planning materiality.

Internationally and nationally, 50% to 70% is regarded as good range to set the performance materiality in.

Now, your performance materiality is 60% (assumed) of your planning materiality.

(25cr*60%=) 15cr.

Therefore, any aggregates equaling this level will act as an alarm for the auditor to perform some detailed checking.

At this stage, we are taking into account the audit risk.

3)  Clearly Trivial Quantity:

This is also a % of planning materiality. This is determined at a very low level thereby getting its name as trivial.

For example 2% of planning materiality can be a CTQ = 50lakh.

Below this level the transactions would be treated as immaterial.

Note:

Even though the misstatements below CTQ are not considered material, if they relate to a certain law or regulation, or the nature of the item is significant, irrespective of its monetary value or size, it will be considered material.

To make things more clear:-

[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, timing 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.

Other points that can be considered:-

• The materiality determined when planning the audit does not necessarily establish an amount below which uncorrected misstatements, individually or in aggregate, will always be evaluated as immaterial.

• The circumstances related to and nature of some misstatements may cause the auditor to evaluate them as material even if they are below materiality.

(For example, Rs.1,000 incorrectly excluded from income may be material even though it's a small percentage of overall income.

• It is not practicable to design audit procedures to detect misstatements that could be material solely because of their nature.]

Revision of materiality

The materiality levels can be revised, may it be planning materiality or performance materiality.

The circumstances which can result in the revision are:

a)    Change in the circumstances that occurred during the audit

b)   New information available to the auditor

c)    Change in the auditor’s understanding of the entity and its operations as a result of further audit procedures.

The auditor’s assessment of Risk of material misstatements can also result in the revision of materiality.

Conclusion

As soon as the audit starts, along with the procedures of SA 300, auditor determines the materiality level for planning and performance of the audit.

At the planning stage auditor determines Planning Materiality (this does not consider the audit risk although its revision may consider the audit risk).

Afterwards, auditor determines performance materiality to safeguard audit risk.

The procedures to select a benchmark or required percentages depend upon the firm of auditors’ policies.

I hope you all like this article. Do leave a comment below and dont’t forget to subscribe to this news letter to get amazing insights into these subjects.