Audit Materiality

Nigel Whittle Accountant EssexPosted by Nigel Whittle:

I still find that when I talk to clients and to professionals who may review and use financial statements, when they see the term “audit” being used, they expect the accounts to be 100% correct.

Hopefully, over the years as I discuss audited accounts with my clients and articles published in the media are read, it becomes clear that an audit ultimately results in the auditor providing an opinion on whether the accounts are materially correct.  This leads on to the question, what is materiality?

A certain amount of guidance is provided under the accounting standards published by the International Accounting Bodies but when all is said and done, it is a judgement call by the auditor.  If the accounts are to show a true and fair view, then the auditor is looking to provide an opinion that the accounts do not include mis-statements which could be expected to influence the decisions of users of the financial statements.  Therefore, it is important not to set the materiality level too high so that material items are not tested but also not to set the materiality level too low so that the volume of work becomes so great, it becomes unnecessary and results in wasteful expenditure. 

It is almost impossible to condense materiality into a single figure.  The auditor will review the financial statements provided and try to assess a benchmark number to use, often based on turnover.  However, this usually results in a large number and could be inappropriate when considering the materiality level for profit or for balance sheet items.  There is no right or wrong answer and often one looks to see what their peer group of similar auditors is selecting to provide a level of comfort through consensus.  Therefore, when using turnover, something between 1% and 2% is often chosen whilst for adjusted profit often the figure is between 5% to 10%.

Nevertheless, each situation is specific to its own circumstances and the choices made must be justified.  For example, where an enterprise is showing a small profit, a small adjustment could turn this into a loss, then is that small adjustment material?  It certainly is to the profit figure.  What the auditor needs to try and assess is what influence the change in the figures may have to any users of the financial information.

The question of materiality will always be a knotty one but one that must be addressed before commencement of an audit and re-visited before the final opinion of the auditor is given to ensure the overall audit process is both effective and efficient.

December 2017

Disclaimer

The views expressed in this article are the personal views of the Author and other professionals may express different views. They may not be the views of Lambert Chapman LLP. The material in the article cannot and should not be considered as exhaustive. Professional advice should be sought in connection with any of the issues contained in the article and the implementation of any actions.

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