Materiality in Auditing - Essay Example

MATERIALITY IN AUDITING By Materiality in Auditing Introduction Materiality in auditing covers the essence of the audit and the information provided with its essence in managing the auditing process. The more material the audit the more applicable the results obtained. The study aims at discussing the materiality aspect in auditing and its support for the auditing process. An audit aims at providing an opinion on the financials of a given entity in relation to fairness as per the required accounting standards. Different audits exist that aim at different aspects that include systems audit, value for money audits, and audit of financials of a company among many other auditing options. All these consolidate the necessary data and provide a position that aids the management of the company in decision-making aspects. For a proper functioning of an audit team in any entity, there is need to ensure a number of items respected and provided for the team. Main Body These include aspects of feeding the audit team with the necessary information that they need for successfully performing their duties and the provision of the necessary personnel to facilitate any information needs of the audit team. As an independent party in the business, an auditor requires to maintain a high level of ethical standards that range from integrity to reasonableness in providing their opinion after the audit. In addition, materiality is a very vital element in the audit process and this relates to the concept that auditing terms and accounting activities base their significance in relation to the amount referred to in the audit, the transactions under review and or any discrepancies that may result or prove identifiable in the process of auditing. Ensuring that these remain respected creates ease in the provision of the objective of an audit which is majorly to provide an auditor with information that enables them make decisions with regard to their opinion on the financials and considering the respect accorded to the materiality concept in accounting and auditing procedures. Materiality according to different accounting and audit firms is represented with the equation materiality is equal to quantity and quality (PWC, 2014). The details of this study aim at relating the aspect of materiality as applied in auditing and accounting. According to Porter et al, 2014 p.73, “the term “material” is of critical importance in the auditing context.” The definition of materiality provides that any financial information provided during an audit must have been prepared in accordance with the audit requirements as set out in the International Auditing Standards (IAS). These define the basic rules that all accountants and auditors must relate with in developing financial statements and their review or provide an opinion for consumption by the different users of financial information. These materials also need to follow the financial reporting framework and the Generally Accepted Accounting Principles (GAAP). According to these requirements, information is proven material if the omission of it or its misstatement will have a profound influence on the economic decisions that result from the users of the information basing on the financial statement provided un to them. The size or magnitude of the errors developed because of the omissions or misstatements determine the materiality of the information. Materiality provides that threshold that provides also a qualitative influence on the information that the auditor finds vital in the audit process (Messier, Bennie & Eilifsen, 2005). These provide the essence of materiality in the auditing process. Materiality provides a quality regulation aspect that ensures that the company obtains results that provide a position that is of essence to the company. According to Mock et al, 2009, p.4, the materiality aspect is considered a secret kept more in comparison with the secret of Coca Cola formula. The aspect of secrecy in auditing is regarded based on the different levels that it is enforced and the ethical requirements of audit work. Proper ethics in auditing require that the information pertaining to the client’s company remain held within the client and the auditor, any disclosures of this information would indicate a breach of confidentiality and could result into legal ramifications for the auditors. For auditing to successfully run its activities with much ease and confidence between the auditor and the client, the client needs to own assurance of the high level of confidentiality that will remain between the two parties. Different companies at different levels in business work between different materiality levels that provide them with their operational validity for development of accounting reports. Form these reports, the auditors perform their activities and relate to the company’s level of operation hence the reliance on the materiality levels of different entities to draw an opinion on their financial statements. In keeping secretes with regard to audit work, the auditors need to ensure high levels of independence in their duties, any aspect that may compromise the auditor’s independence may require the auditor to rescind the offer and let another audit team take over the audit role. Aspects that may affect the independence of the auditor may include possession of shares in the company to be audited, running audits for different subsidiaries that the company may hold, or even any existing relationship between the audit parties and the company that may bias their decisions on the opinion given. A business is a separate entity that needs protection from any activities that may threat its existence and success. This as related on the concept in accounting that looks at the business as a very separate entity from the owner provides grounds that auditor’s base on to follow their ethical requirements in relation to looking at the business more compared to the business owners. The different value parameters developed with regard to valuing materiality range from a non-zero, or a non-negative constant, a constant that lies between zero and one provides a material measure for any revenue account, or transaction under review. It is basing on this relationship that one discovers that the materiality that a company holds relates to the size of the company and the nature of the business that they run. Big companies hold huge materiality levels while small companies run within a small materiality level. Based on these aspects, the different levels of secrecy develop but also the ethical composition of the audit role provides the need to maintain secrecy in all aspects as a demand that also serves to improve the relationship between the auditor and the business entity. According to academic research in the auditing field, materiality relates to aspects that may help the auditor avoid misjudgments, misstatements that may affect their audit opinions as in reports (Financial Reporting Council, n.d, p.2). These aspects if not followed can lead to exposure to great audit risks that may affect the results of the works of the auditor and provide wrong information that may be used for decisions making hence leading to poor decisions that may not necessarily provide a fair judgment on the financial statement of a business entity. Auditing is a highly risky area that requires consideration of all aspects before one involves in the actual audit. Ensuring that all the necessary information pertaining to the audit is obtained is what all auditor targets before proceeding with an audit exercise. For regulation of the audit aspect on materiality, a number of common rules have been developed that range from those developed in practice and those that academia aspects have developed to quantify the materiality aspect in the accounting and auditing fields (Accounting-simplified.com, 2013). These rules include the percentage of the pre-tax income that the company holds or its net income. This rule requires that 5% of the average pre-tax revenues basing on a three-year average be applied. The materiality aspect also should consider the percentage in gross profit the company holds, the total assets percentage that relates to 1/3% of the company’s total assets, 1/2 % of total revenues that the company holds in relation to its percentage revenues in total and the percentage of the equity that the firm holds. Considering finding, the materiality that the company holds requires a combination of these items above developing a mix that defines an average of the items involved. Application of these methods also may vary with the size of the business entity under consideration. This aspect is referred to as the sliding scale. Other academic developments have also developed the concave function as another way of determining materiality that the company holds. The concave function applies the aspects of a gauge that is a measure through which decreasing returns to the scale provided is respected. Through the concave consideration, a low level of materiality is obtained that means a lesser level of misstatement. Many companies rely more on their financials as they grow bigger hence the need for a continued review of the materiality levels (Perry, 2014). The consumption of different means of determining materiality may develop inconsistencies in materiality levels. Planning materiality is essential in developing valid materiality levels that may affect the scope applicable in the business. The scope is established through a number of means that range from tests that establish control and substantive tests to establish any differences that may prove vital in the process of auditing. These may explain why different auditors may provide differing positions on the same company with regard to materiality based on the method chosen and may end up with very different procedures of auditing. In the accounting and audit fields, changes that may result normally base on the need to either improve or simplify the processes or regulations developed or develop very different regulations that help in controlling different aspects in accounting. These developments may also aim at the provision of guidelines that auditors use in relating different audit procedures and coming up with solutions to any challenges that may arise. Audit regulations are developed around the different audit needs and have for years guided the actions of auditors and their works. The changes to the regulations that have based heavily on the developments that aimed at controlling the audit aspect have featured a number of changes that include those affected as from 15 December 2009. These changes developed more materiality principles whose objective is the enhancement of proper application of the materiality concept in planning and the performance of audits. Through the same regulations, performance of audits was defined as the low levels set by auditors at which the company’s level of materiality provides it with ability to have minimized misstatements. The auditors also determine materiality and perform materiality checks and aspects with regard to the needs of the client and ensuring that the needs met provide an aiding aspect to the auditor for their duties to run smoothly and result into a fair view and realistic position on the financials of the company. Through these developments, more reliable reports are developed that provide a good and realistic position on the accounts of the business entity providing better guidance to decision making in the business. During the audits, constant reviews of the audit materiality levels will ensure that the auditor is in the right lie of materiality leading to more consistently developed results in the reports and a fair position on the business. In the reports according to the changes made to the standards, the auditor includes among the following the materiality levels involved for the financial statements, the materiality levels of different transaction classes, accounts’ balances and the aspects of disclosures as permitted by the standards (International Standards on Auditing 320, 2013, p.325). In addition, performance materiality and nay changes to the materiality levels are developed in the reports as part of the disclosures that the client needs to identify. Based on the changes made and the intentions for the changes, it is possible to say that the changes made are for the better. More often, the changes made to the accounting and auditing standards aim at filling a gap identified like for this case a gap in materiality. Ensuring that standards are set on all aspects of auditing and accounting is the responsibility the standards board aims at when developing these regulations. Based on the propositions made and the needs of the auditing profession, the changes made provide audit clients with more information on their company putting them in better places to make better decisions. Conclusion The audit process establishes an opinion to the audited material based on the evidence collected by the auditors with regard to the transactions of the company. The different reasons for the audit process are to provide a fair opinion on the works. In auditing, ethical efforts play a vital role and their management plays a major role in the auditing process. The aspect of independence feature in the auditing process and through them an auditor’s work is considered ethical. A fair position in the audit report gives the management of the organization a simple trusted approach in decision-making. These prove applicable based on their following of the International Standards of Auditing (Sage, 2014). Bibliography Accounting-simplified.com, 2013. Materiality. Retrieved from http://accounting-simplified.com/financial-accounting/accounting-concepts-and-principles/accounting-materiality.html Financial Reporting Council, n.d. Illustrative Example of a UK auditor’s Report Reflecting Requirements of ISA (UK and Ireland) 700. Retrieved from 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 International Standards on Auditing 320, 2013. International Standards on Auditing 320 Materiality in Planning and Performing Audit. Retrieved from https://www.ifac.org/sites/default/files/publications/files/A018%202013%20IAASB%20Handbook%20ISA%20320.pdf Messier, Bennie & Eilifsen, 2005. A Review and Integration of Empirical Research on Materiality: Two Decades Later. Social Science Research Network. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=786688 Mock, T. et al. 2009. The Unqualified Auditor’s report: A Study of User Perception, Effects on other user Decisions and Decision Processes and Directions for Further Research. New York. Retrieved from http://www.ifac.org/sites/default/files/downloads/Study__1_ASB_Summary_Report.pdf Perry, L. 2014. Auditing Special Purpose Frameworks: Materiality Levels. Accounting Web. Retrieved from http://www.accountingweb.com/article/auditing-special-purpose-frameworks-materiality-levels/223509 Porter, B. et al. 2014. Principles of External Auditing (4th ed.), pp. 73-77, 350-361. PWC, 2014. Materiality in Audits. Retrieved from http://www.pwc.com.au/assurance/publications/audit-committee-guide/materiality-in-audits.htm Sage, 2014. Materiality in Financial Statement Audit. Retrieved from http://www.pastel.co.za/Other-Pastel-Products-Software/Pastel-Auditor/Materiality-in-a-financial-statement-audit.asp Read More