This International Standard on Auditing (ISA) deals with the responsibility of the auditor to apply the concept of materiality or materiality in planning and conducting an audit of financial statements. ISA 450 explains how materiality is applied in evaluating the effect of errors identified in the audit and of uncorrected errors, if any, on the financial statements.
Materiality in the context of an audit
Financial reporting frameworks often discuss the concept of materiality or materiality in the context of the preparation and presentation of financial statements. Although financial reporting frameworks can discuss materiality in different terms, they generally explain that:
- Errors, including omissions, are considered material if, individually or collectively, they are expected to be reasonable to influence the economic decisions that users make on the basis of the financial statements;
- The materiality criteria are made based on the circumstances that surround them, and are affected by the size or nature of an error or a combination of both, and
- Criteria for matters that are important to users of financial statements are based on consideration of the common needs of users, as a group, of financial information. The possible effect of errors is not considered for certain individual users, whose needs may vary widely.
The auditor's determination of materiality is a matter of professional judgment, and is affected by the auditor's perception of the financial information required by users of financial statements. In this context, it is reasonable for the auditor to assume that users:
- They have a reasonable knowledge of the business, economic and accounting activities and the willingness to study the information in the financial statements with reasonable diligence; They understand that financial statements are prepared, presented and audited for levels of materiality or relative importance; They recognize the uncertainties inherent in the valuation of amounts based on the use of estimates, criteria and the consideration of future events, and They make reasonable economic decisions based on the information in the financial statements.
Definitions
For the purposes of the ISA, materiality or materiality for the performance of the engagement refers to the figure or figures determined by the auditor, below the materiality level established for the financial statements as a whole, in order to reduce to a adequately low level the probability that the sum of the uncorrected and undetected misstatements will exceed the materiality determined for the financial statements as a whole. Where appropriate, the materiality for the execution of the work also refers to the figure or figures determined by the auditor below the level or levels of materiality established for certain types of transactions, accounting balances or information to be disclosed.
Requirements
Determination of the relative importance for the financial statements and for the execution of the work, when planning the audit.
The auditor will determine the materiality of the work in order to assess the risks of material misstatement and to determine the nature, timing and scope of the audit procedures.
A3. The determination of materiality implies the exercise of professional judgment. Often a percentage is applied to a benchmark chosen as a starting point to determine materiality or materiality for the financial statements taken as a whole. Factors that can affect the identification of an appropriate reference point are the following:
- The elements of financial statements (for example, assets, liabilities, equity, income, expenses); If there are items on which the attention of users of an entity's financial statements tends to focus (for example, for the purpose of evaluating financial performance, users tend to focus on profits, income, or net assets); The nature of the entity, the entity's life cycle, the industry, and the economic environment in which the entity operates; The entity's structure, ownership, and form of financing (for example, whether an entity is financed exclusively with debt rather than equity, users may place more emphasis on assets, and claims on them, than on the entity's income), and the relative volatility of the benchmark.
A7. Determining a percentage to apply to a chosen reference point implies the exercise of professional judgment. There is a relationship between the percentage and the chosen benchmark, in such a way that a percentage applied to earnings before taxes from continuing operations will normally be higher than a percentage applied to total income. For example, the auditor may consider five percent of the pre-tax profit from continuing operations might be appropriate for a for-profit entity in a manufacturing industry, while the auditor may consider one percent of the total revenue.and expenses, may be appropriate for a non-profit entity. However, depending on the circumstances, higher or lower percentages may be considered appropriate.
Specific Considerations for Public Sector Entities
A9. In auditing a public sector entity, total cost or net cost (expenses less income or expenses less perceived) may be appropriate benchmarks for scheduled activities. When a public sector entity has custody of public assets, the assets may be an appropriate reference.
Review as the audit progresses
The auditor will review the materiality for the financial statements taken as a whole (and, if applicable, the level or levels of materiality for certain classes of transactions, account balances or disclosure) if available, during the performance of the audit, of information that, if it had initially had it, would have led it to determine a different figure (or figures).
If the auditor concludes that a materiality less than that initially determined is appropriate for the financial statements as a whole, the auditor should determine whether it is necessary to review the materiality result for the performance of work, and whether the nature, timing and extent of the initially established post audit procedures remain adequate.
Documentation
The auditor shall include in the audit documentation the following amounts and the factors considered in their determination:
- Materiality for the financial statements as a whole. If applicable, the level or levels of materiality for certain types of transactions, accounting balances or information to be disclosed; Relative importance for the execution of the work. Any revision of the figures established in (a) - (c) as the audit progresses.
