Materiality in Auditing - Essay Example

MATERIALITY IN AUDITING Table of Content Introduction Auditing involves a system of reviewing financial ments in order to give an independent view of whether the financial statement shows a true and fair view or not. Basically, it is rare for an auditor to check every transaction in the financial statements, hence there is the need for the auditor to concentrate efforts on the most important and relevant aspects of the client’s financial statements (Millichamp & Taylor, 2012). This major demand requires that the auditor must assess the audit risk and ensure that the opinion passed on the financial statements is accurate and really defines the state of the financial statements. Therefore, an auditor has to set a materiality level for important and vital aspects of the audit in order to concentrate and focus on the areas that are important and necessary. This paper examines the role of materiality in auditing and how this can be achieved in the best way and manner possible. In order to attain this end, the following objectives will be explored: 1. A critical evaluation of the relevance and importance of materiality in external auditing; 2. An evaluation of the causes of variations and confidentiality in choosing materiality 3. An assessment of the considerations and complications in defining materiality; 4. A review of the role of audit regulation in relation to audit reporting that have affected the disclosure of materiality Relevance of Materiality The Financial Accounting Standards Board (FASB) defines materiality as “the magnitude of an omission or misstatement of an accounting information that, in the light of the surrounding circumstances, makes it probable that the judgement of a reasonable person relying on the information will have been changed or influenced by the omission or misstatement” (Johnstone, et al., 2013 p268) This implies that materiality is about the important issues and matters which when overlooked, will cause the financial statement to be overly misleading. Therefore, in the auditing context, materiality involves a situation whereby the auditor examines and reviews important things in his analysis of the financial statements in order to ensure that the opinion they pass on the financial statement are valid and reliable. Materiality affects sample sizes and determines whether the financial statement needs adjustments or not, and it represents the difference between a qualified and an unqualified report (Bagshaw & Selwood, 2013). This shows how the auditor can estimate the levels of issues that matter and then define the way and manner in which work can be distributed and conducted throughout the entire audit. This therefore means that materiality informs an auditor of which aspects of the financial statement amounts are to be given certain levels of attention. This gives the auditor guidelines on how to evaluate and analyse things and the extent to which focus should be given to certain components of the financial statement. Variation and Confidentiality of Materiality Materiality is to be defined on a case-by-case basis. It involves the integration of professional judgement. It is done by examining the entire financial statement as a whole and this will help the auditor to identify what is important and from there, the auditor can state the scope of work to be done and how it will be done. After examining the general scope of the work, there is the need for an auditor to check specific balances in order to identify the extent of work that should go into the specific features of the financial statements. This will include an analysis of general industry trends and specific circumstances of a the client in the period under review. It is only after these evaluations are done that materiality can be realistically defined and applied in the case of a given audit. Materiality is therefore fixed after the audit process commences. It is supposed to be kept confidential becuase the scope of auditing must not be leaked to the client. This means that the materiality limits are to be kept to the audit team only. And during the audit process, the auditors must use it to guide their steps alone without getting the auditees to know what is going to be done at any given point. The review of the overall information will give rise to audit materiality whilst the review of information relating to the specific classes of data will define the financial materiality (Jagd, 2013). In order to examine audit materiality, the auditor will need to evaluate the working papers of the client to assess the auditing history of the firm (Collings, 2013). Secondly, there is the need to conduct risk assessment at the entity level and conduct meetings with the client’s management in order to get a general view of the materiality levels that might be appropriate to the firm (Collings, 2013). For financial materiality to be defined, there is the need for a more thorough and critical analysis of misstatements and the nature of these misstatements. ISA 320 identifies that the scope of materiality is to be defined by the scope of faulty information and omissions, nature of misstatements and matters that are material to users of the financial statement (Jagd, 2013). This will guide the auditor to define the scope and extent of materiality in order to carry out the audit and do things in a way and manner that will allow them to set the materiality limits for the different classes of financial statement classes. Complication in defining Materiality . Auditing Regulations and Disclosure of Materiality Recommendations on Changes in Materiality Rules in Auditing Conclusion The full text of the current International Standard on Auditing ISA 320 Materiality in Planning and Performing an Audit can be accessed on the website of the International Federation of Accountants (IFAC) at The IFAC website also contains the research report from which the second abstract in the essay question is taken, Mock, T. et al. (2009) The Unqualified Auditor’s Report: A Study of User Perceptions, Effects on User Decisions and Decision Processes, and Directions for Further Research, at http://www.ifac.org/sites/default/files/downloads/Study__1_ASB_Summary_Report.pdf. A review of academic research on materiality to 2005, Messier, W. et al. (2005), A Review and Integration of Empirical Research on Materiality: Two Decades Later, can be accessed at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=786688. A review of current audit practice in relation to materiality in the UK can be found in the recent Financial Reporting Council (FRC) publication, FRC (2013), Audit Quality Thematic Review – Materiality, available at https://frc.org.uk/Our-Work/Publications/Audit-Quality-Review/Audit-Quality-Thematic-Review-Materiality.pdf. This document also provides brief coverage of the recent changes to audit reporting in the UK. The FRC website provides a generic example of the revised audit report now used in the UK at https://www.frc.org.uk/Our-Work/Publications/Audit-and-Assurance-Team/ISA-700-%28UK-and-Ireland%29-700-%28Revised%29/Illustrative-example-of-a-UK-auditor-s-report.aspx. Examples of such audit reports can also be found in the annual reports of UK companies for years ended from 30 September 2013 onwards. An example can be accessed at http://www.tescoplc.com/files/pdf/reports/ar14/download_annual_report.pdf, pp.65-68. You may, of course, also wish to explore other authoritative sources in writing your essay. Bibliography Bagshaw, K. & Selwood, J., 2013. Core Auditing Standards for Practitioners. Hoboken, NJ: John Wiley and Sons. Collings, S., 2013. Interpretation and Application of International Standards on Auditing. Hoboken, NJ: John Wiley and Sons. Jagd, J. T., 2013. Investor Oriented Corporate Social Responsibility Reporting. London: Routledge. Johnstone, K., Gramling, A. & Rittenberg, H., 2013. Auditing: A Risk-Based Approach to Conducting a Quality Audit. 3rd ed. Wadsworth: Cengage. Millichamp, A. & Taylor, J., 2012. Auditing. Wadsworth: Cengage. Read More