1 Audit Materiality. 2 Audits provide reasonable assurance that the financial statements are free of...
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Audit Materiality
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Audits provide Audits provide reasonable assurance reasonable assurance that the financial statements arethat the financial statements arefree of free of material material misstatements.misstatements.
Audits provide Audits provide reasonable assurance reasonable assurance that the financial statements arethat the financial statements arefree of free of material material misstatements.misstatements.
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Materiality – Definition (Framework)
• "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 cutoff point rather than being a primary qualitative characteristic which information must have if it is to be useful."
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USERUSER FOCUSFOCUS
Materiality is defined in termsMateriality is defined in termsof financial statement usersof financial statement users
Materiality is defined in termsMateriality is defined in termsof financial statement usersof financial statement users
Therefore no hard and fast rulesTherefore no hard and fast rules Therefore no hard and fast rulesTherefore no hard and fast rules
Need to consider multiple users and multiple basesNeed to consider multiple users and multiple basesNeed to consider multiple users and multiple basesNeed to consider multiple users and multiple bases
Materiality can be on Qualitative/ Quantitative Materiality can be on Qualitative/ Quantitative factorsfactors
Materiality can be on Qualitative/ Quantitative Materiality can be on Qualitative/ Quantitative factorsfactors
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SET PRELIMINARY JUDGMENTSET PRELIMINARY JUDGMENTABOUT MATERIALITYABOUT MATERIALITY
Base X (function of client)Base X (function of client)
Percentage (function of audit risk)Percentage (function of audit risk)
== Preliminary estimate of materialityPreliminary estimate of materiality
Factors Affecting JudgmentFactors Affecting Judgment
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Typically 1 - 5% for net income, lowerTypically 1 - 5% for net income, lowerpercentage for larger bases such aspercentage for larger bases such as
assets or revenuesassets or revenues
High Risk Low % ML
Low Risk High % ML
(less evidence; less assurance)(less evidence; less assurance)
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Materiality / EvidenceMateriality / EvidenceRelationRelation
Increase inIncrease inMaterialityMateriality
LevelLevel
Increase inIncrease inMaterialityMateriality
LevelLevel LessLess
evidenceevidence
requiredrequired
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Materiality Level /Materiality and Audit Risk
• There is a positive relationship between materiality level and audit risk
• There is a negative relationship between materiality and audit risk
Materiality Level = Audit Evidence ↓ = Audit Risk
Materiality = Audit Evidence = Audit Risk ↓
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Materiality Should be Considered by the Auditor When:
(a) Determining the nature, timing and extent of audit procedures;
and
(b) Evaluating the effect of misstatements.
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Evaluating the Effect of Misstatements
In evaluating whether the financial statements "give a true and fair view" or "present fairly, in all material respects,", the auditor should assess whether the aggregate of uncorrected misstatements that have been identified during the audit is material
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Evaluating the Effect of Misstatements
• The aggregate of uncorrected misstatements comprises:(a) Specific misstatements identified by the
auditor; and
(b) The auditor's best estimate of other misstatements which cannot be specifically identified.
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Evaluating the Effect of Misstatements
• When aggregate uncorrected misstatements approach the materiality level the auditor would consider reducing the risk by
1. Performing additional audit procedures or
2. By requesting management to adjust the financial statements for identified misstatements
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Evaluating the Effect of Misstatements
• ExampleAn auditor discovered an overstatement of Rs. 20,000/- of inventory by verifying a sample of 100,000/- worth of inventory. The B/S value of inventory is Rs. 200,000/-. The preliminary materiality level set by the auditor is Rs. 30,000/-.
Required : Find if the misstatement is material or not.