Materiality: 1) What is materiality and why is difficult to apply the concept? 2
ID: 2579814 • Letter: M
Question
Materiality:1) What is materiality and why is difficult to apply the concept?
2) As an auditor, how do you identify who the primary users of the entity’s financial statements are, and the information those users need to find in the financial statements?
3) What factors should be considered in deciding whether information is material or not?
4) How is the presentation (e.g. aggregation/ disaggregation) of information influenced by materiality and vice versa?
5) During the course of an audit, both quantitative as well as qualitative misstatements need to be considered. Give four examples of qualitative misstatements. Materiality:
1) What is materiality and why is difficult to apply the concept?
2) As an auditor, how do you identify who the primary users of the entity’s financial statements are, and the information those users need to find in the financial statements?
3) What factors should be considered in deciding whether information is material or not?
4) How is the presentation (e.g. aggregation/ disaggregation) of information influenced by materiality and vice versa?
5) During the course of an audit, both quantitative as well as qualitative misstatements need to be considered. Give four examples of qualitative misstatements.
1) What is materiality and why is difficult to apply the concept?
2) As an auditor, how do you identify who the primary users of the entity’s financial statements are, and the information those users need to find in the financial statements?
3) What factors should be considered in deciding whether information is material or not?
4) How is the presentation (e.g. aggregation/ disaggregation) of information influenced by materiality and vice versa?
5) During the course of an audit, both quantitative as well as qualitative misstatements need to be considered. Give four examples of qualitative misstatements.
Explanation / Answer
1 ANSWER :- The term "Materiality" means significant / important. An item may be considered as material if it's Misstatements or omissions will misrepresent the view given by the financial statements.
The concept of Materiality acts as a filter helping the management to ensure that the financial statements include all the material information I.e.the financial information that would influence users investment decisions and excludes information tat is not material in order to present material information is clear ad effective manner.
Whether information is material or not is a matter of judgement based on a range of factors and entity specific circumstances. Currently there is a lack of guidance to help the management understand how to apply the concept of Materiality when preparing financial statements.
2. ANSWER :- The auditor can rely on the accounting standards which are applicable to all general purpose financial statements in order to trace out the entities interested in the financial statements such as Management, proprietor, shareholders, lenders banks and financial institutions, suppliers, customers, government, research scholars, employees etc.....
The information which the users need in the financial statement are :-
1. To determine the financial position and the strength of the company debt service coverage etc
2. To determine the credit worthiness of the company
3. To know the general business viability before entering into long term contracts and arrangements
4. For study research and analysis purpose
5. To ensure performance and contribution to social objectives
6. For day to day decision making and performance evaluation
3 ANSWER :- The decision of Materiality is a professional judgement of auditors. The auditor should consider the following while deciding upon the Materiality.
(a). Sometimes the financial reporting framework may prescribe the Materiality levels. In thone cases the auditor should follow those Materiality levels. For example:- while verifying cash payments the auditor needs to ensure that there are no cash payments in excess of Rs.20,000/- as per section 40 A (3) of income tax act.
(b). If the financial reporting framework is silent with respect to Materiality then the auditor should decide upon the Materiality applying his professional judgement based upon size of the relative item, impact of the relative item on financial statements and nature of the relative item.
(c). Materiality is a relative term. For example, Rs.1000 mayesha be material amount for a small concern, but this may not be material for a large company.
(d). An item may not be important in current year but it is important when compared with previous year then that item would become material or important this year also.
(e). A small mistake or fraud may be considered material if it converts a small prefit into loss or vice versa
(f). Several individual immaterial or unimportant items together may become a material amount in total.
(g). In setting off the transactions or items care must be taken so that items which are independently material are not set off against each other. For example- the surplus arising from a change in the accounting policy may not be set off against a non recurring loss.
(h). Even a small amount may become material if it's disclosure is essential.For example:- a payment of Rs. 100 to directors as remuneration in excess of the limits will be material.
4 Answer :- material assessment also involves making sure that the information that is important to the users is not observed by immaterial information. Thus undermining the usefulness of the financial statements.
However it is also not appropriate to assume that only disclosure items specified in the IR'S is sufficient one needs to step back and enature that the information provided is faithful.
5 Answer :- Misstatements is the difference between the amounts, classification, presentation or disclosure of a reported financial statement financial statement item and required for the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or fraud.
Qualitative mistatement relatespecially to the quality of the mistatement where an error occurs caused by a junior accounts clerk would be less likely to be considered material then a deliberate fraud by a director even if they were for the same amount.
Quantitative mistatement relates to the size of the mistatement the length it is the more likely it is to be matrial.
Examples of qualitative mistatement are as folows:-
1. Matters which impact on the integrity of the financial records.
2. Matters which indicate weaknesses in he entity's system of internal control which may have further impact in various aspects of the financial reporting process.
3. Failure to disclose a breach of regulatory requirements when it is likely that the consequent imposition of regulatory restrictions may significantly impair operating capability.
4. The adequate or improper description of an accounting policy when it is likely that a user of the financial report will be misled by the description.