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8. Guidance on materiality
It’s all very well saying that a matter is material if it would reasonably influence decisions
of a user of
the auditor’s report, but that gives very little guidance to the audit team (or to you when you are
doing a question).
Therefore, some rules of thumb have been developed. These are only guidelines, but if something is
wrong to the extent of:
๏
0.5% to 1%
of revenue,
๏
1% to 2% of total assets or
๏
5% to 10% of profit
then you should assume that the matter is material. These percentages should take into account the
auditor’s knowledge of which
items users will focus on, the nature of the entity (life cycle/
environment), its ownership, structure and financing and the volatility of the benchmark.
Additionally, a lesser amount should be set for materiality when designing and carrying out audit
procedures to reduce the risk that misstatements in aggregate exceed financial statement materiality.
This is known as
performance materiality
: the materiality that is important
in the performance of the
audit work.
Errors which are less than the suggested guidelines could still be regarded as being material. An error
which turns a small loss into a small profit could cause unfounded optimism in some situations,
perhaps a feeling that the company has turned a corner. So, although in absolute terms, the size of an
error is relatively small, the way in which the accounts are then
interpreted could lead to
unreasonable decisions being made. Therefore, you can talk about both quantitative and qualitative
materiality.
Finally, there are some amounts in the financial statements where no errors are tolerable. For
example, there is often a statutory duty to disclose directors’ remuneration and that has to be stated
with absolute accuracy.
All misstatements identified should be communicated to management who should be asked to
correct them or to explain why not. The auditors must assess the materiality of uncorrected
statements and obtain written representations from management that they believe uncorrected
misstatements to be not material. (see Chapter 28)
If management refuses to correct an error that the auditor thinks is material then the auditor
will issue
a modified (qualified "except for") audit opinion.
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