January 29, 2022

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Materiality Concept in Auditing with ISA 320 Explanation

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The materiality concept is important in accounting and auditing. Audit partners cannot examine a business financial statement without assessing the materiality. The International Standard of Audit (ISA) 320 explains this term in detail.

Definition of Materiality Concept

The definition of the materiality concept depends on where you are looking at it. But all definitions have the same implications. According to IFRS “information is material if omitting, misstating, or obscuring it could reasonably be expected to influence decisions that the primary users make based on those financial statements.”

The US GAAP states it as “The omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.”

However, the International Standard of Audit (ISA) 320 sees the materiality concept as what should be applied when planning the audit and during the performance of the audit.

Therefore, it defines performance materiality as “the amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.”

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In addition, the standard states “If applicable, performance materiality also refers to the amount or amounts set by the auditor at less than the materiality level or levels for particular classes of transactions, account balances, or disclosures.”

Key Explanations

The materiality concept is affected when in a business there is an error, omission, or misstatement. These occur in the financial statements. Auditors are expected to state if the financial statements are true and fair. But that’s not all. He or she must state whether the statements are free from material misstatement.

The principle is both quantitative and qualitative. An amount of N1000 that is misstated is immaterial to the partner. However, an omission of N1 million from the balance sheet may raise an eyebrow by the audit team. This will trigger a more in-depth examination of the business records.

But, one million Naira may be immaterial to another company. For example, a company with a total asset base of 4 million Naira will find this case material because that’s 25 percent of its total assets. However, a company with an asset base of 50 billion may see this as immaterial. As it’s only 0.002 percent of the assets.

However, the qualitative aspect of the omission must be considered. A one million Naira error may be a fraud by an employee or director of the entity. Therefore, this calls for further investigation.

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According to ISA, the materiality concept is applied from the planning phase. The auditor must set materiality limits base on his or her judgment and assessment of the company. He or she can set several amounts for different classes of transactions, account balances, or disclosures.

Other things stated by ISA 320 on Materiality Concept

1. 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 taken based on the financial statements;

2. Judgments about materiality are made in light of surrounding circumstances, and are affected by the size or nature of a misstatement, or a combination of both; and

3. Judgments about matters that are material to users of the financial statements are based on a consideration of the common financial information needs of users as a group. The possible effect of misstatements on specific individual users, whose needs may vary widely, is not considered.

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Conclusion

Materiality concept affects the accounting information presented in financial statements. If there is a material statement or omission, it will affect the decisions of the various users that relied on such statements. Therefore, auditors ensure that it tests the company’s report for it.

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