QS Study

Determining the Materiality Level of the Financial Statements

Financial statements are materially misstated when they contain errors or irregularities whose effect, individually or in the aggregate, is important enough to prevent the statements from being presented fairly in accordance with Accounting Standards. In this context, misstatements may result from misapplication of applicable Accounting Standards, departures from fact, or omissions of necessary information.

In audit planning, the auditor should recognize that there may be more than one level of materiality relating to the financial statement. Each statement, in fact, could have several levels. For the Income Statement, materiality could be related to total revenues, operating profit, net profit before tax, or net profit. For the Statement of Financial Position materiality could be based on shareholders’ equity.

Quantitative guidelines –

In assessing the quantitative importance of a misstatement, it is necessary to relate the rand amount of the error to the financial statement under examination. While planning the examination, the auditor generally a concerned only with misstatements that are quantitatively material. In evaluating audit evidence, the auditor considers both quantitative and qualitative misstatements.

Qualitative considerations –

The emphasis in planning materiality is on quantitative considerations. Since the errors are not yet known, their qualitative effect can be considered only during the testing phase of the audit as evidence becomes available. Qualitative considerations relate to the causes of misstatements. A misstatement that is quantitatively immaterial may be qualitatively material. This may occur for instance, when the misstatement is attributable to an irregularity or an illegal act by the client. Discovery of either occurrence might cause the auditor to conclude there is a significant risk of additional similar misstatements.

Other examples of qualitative misstatements are:

(a) An inadequate or improper description of an accounting policy, when it is likely that the users of the financial information are misled by the description.

(b) A change in accounting method which is likely to affect materially the results of subsequent financial years.

(c) A related party transaction or event requiring disclosure.

(d) Although it is suggested that the auditor should be alert for misstatements that could be qualitatively material, it ordinarily is not practical to design procedures to detect them.