Analysis of Materiality in Auditing - Essay Example

Materiality in Auditing by s s Materiality is a familiar concept or even a convention thatis vastly used in auditing and accounting (Ruhnke, Pronobis & Michel, 2014, p. 13). It predominantly relates to the importance of a given amount, discrepancy or transaction. The intent of audits is to enable an auditor to identify if financial statements are well prepared within the material aspects and in accordance with a specified framework (Eilifsen & Messier, 2014, p. 34). This is an isolated responsibility and a distinct decision from the one made by an entity in the event of preparation of financial statements. This paper delves into the background of materiality in auditing, to provide information about its importance, the secrecy involved and its significance, the changes that have occurred in its practice. During auditing, materiality means not only any amount that is quantifiable, but also the impacts that the amount quantified will make in several contexts (Eilifsen & Messier, 2014, p. 56). In the audit process and planning, the auditor decides the level of materiality by taking into consideration the entire financial statement that is to be reviewed (Ruhnke, Pronobis & Michel, 2014, p. 13). Materiality in auditing relates to the content of the financial statements, the level and the kind of testing that is to be carried out. The decision made in materiality auditing is based on the analysis of misstatements. Besides, the decision made is also affected by the legislative and regulatory needs and the expectations of the public. In the event of auditing, the auditor may need information that may lead to the determination of different materiality (Ruhnke, Pronobis & Michel, 2014 p 14). This will require the materiality to be thoroughly revised. Financial Accounting Standards Board (FASB) has always refrained from stipulating quantitative guidelines that can be used to determine materiality (Eilifsen & Messier, 2014, p. 67). This has caused confusion when mainly using Auditing Standards Number 47. Several rules have been applied to quantify materiality including the percentage of net income, the gross profit, total assets, total revenues, equity and the concave function. Importance of Materiality The debate and the controversy about the significance of materiality have proliferated in many businesses today (Ruhnke, Pronobis & Michel, 2014, p. 24). Of course, the answer can be relative depending on how good or poor the materiality is carried out. This paper finds it to be very vital. Financial information is deemed to be pivotal to determine the performance of a business entity. Financial statements inform the interested parties about the worth of the entire company, its value and the existing significance of its daily transactions (Eilifsen & Messier, 2014, p. 35). Those who use the financial information have the assumption that companies often comply with the principles of accounting when they are creating the financial statements. Based on the existing conventions of accounting, this can be true if the application cost of the principles of accounting does not surpass the benefits of being able to do so. For instance, the concept of materiality will enable an enterprise to depart from the financial principles of accounting in case the transaction is deemed insufficient in size to attract the concern of the users and their financial statements. The manner in which a business accounts for its operation determines the material impact on the worthiness of the financial statements up to the document’s readers (Ruhnke, Pronobis & Michel, 2014 p 27). Information is considered material if it is of misstatement or its omission can influence the judgment of those who rely on the data that is conveyed by the reports (Eilifsen & Messier, 2014, p. 34). The nature of the company and how it operates, the kind of the item and its monetary size can influence the materiality of the information provided. If the dollar amount of a transaction is relatively inconsequential in nature to the enterprise’s primary operation, then the business may be compelled to consider the immaterial information (Eilifsen & Messier, 2014, p. 89). In such a case, a company may forgo the method of accounting that is suggested by the principles of accounting. It will, instead, opt to use a method that is less costly or expedient in order to account for the transaction. One business’ threshold for materiality can differ from another, and there is the likelihood of the threshold varying with time. Materiality is said to be a subjective concept which enables a business to measure and disclose transactions that are deemed only of higher value and are also attractive to the users of the business’ financial statements (Ruhnke, Pronobis & Michel, 2014, p. 13). An enterprise should be able to account for such substantive amounts in a manner that coheres with the principles of accounting. Nevertheless, materiality is often measured regarding the dollar amounts and the existing nature of misstatements (Ruhnke, Pronobis & Michel, 2014, p. 23). Thus, each business is capable of determining the items that are virtually material within its guided ways of operation. It can also justify the costs of labor incurred in the adherence to the accounting principles in the event of accounting for those particular items. Materiality aids the CPAs in management of their responsibilities (Eilifsen & Messier, 2014, p. 76). This is realized by following the four perspectives of materiality, where each has its unique quantitative way of calculations and the limits. In order to determine which materiality level in use, CPAs must find out the nature and kind of the financial statements and their effect at hand. The first perspective entails actual misstatement to error within the financial statements and is seen to be familiar to many CPAs (Ruhnke, Pronobis & Michel, 2014, p. 53). It is an error in dollar, which can also be calculated. The second case is internal control deficiency that has been caused by operation of a control failure. The third perspective is not an exception; it is considered a significant variance that occurs in accounting estimate that is compared with the initially determined amount. The fourth entails financial fraud by executive or management or some employees in order to confirm the financial position of the company. Confidentiality in Materiality To be an auditor is quite demanding. The client entrusts him or her with information that is very sensitive (Eilifsen & Messier, 2014 p 45). This has prompted companies to put emphasis on the confidentiality in materialism. In fact, the level of secrecy today has increased in most businesses. A good editor is not supposed to betray the expected confidentiality nor permit the revelation of the information that is considered to be highly or just sensitive. A breach of secrecy or confidentiality is almost unforgivable. It is conceivable that during materiality auditing, information that is prone to cause damage to the client may be discovered (Ruhnke, Pronobis & Michel, 2014 p. 45). The objective of an auditor is to be able to detect such irregularities or even the illegal acts that have transpired within any financial transaction. Self-protection requires utmost caution and least privilege in many activities (Eilifsen & Messier, 2014, p. 34). The principle of "least privilege" entails the provision of only minimum information that is necessary to accomplish a task. The auditor has the responsibility of implementing security measures for the purpose of maintaining the needed confidentiality. Often, auditors utilize working papers, reports that have been composed, spreadsheets and checklists which have details and secrets that must be protected at all costs (Ruhnke, Pronobis & Michel, 2014, p. 66). This is mainly because the information being privy can be alarming to a section of people, inflict gross damage to others or even instigate additional actions from the perpetrators. In achieving high level of secrecy in materiality, auditors have employed the many mechanisms or principles that guide them in operation (Ruhnke, Pronobis & Michel, 2014, p. 33). Sensitive information belongs to the owner and should not be leaked during and after auditing to third parties. The auditors are advised to seek legal advice regarding confidentiality and the laws that dictate the disclosure to the right authorities. The basics principles of confidentiality should also not be followed at all times. Auditors should consider the use of locking security cables and the securing their laptops with passwords. Privacy helps an auditor gain respect and good reputation. Document file archives should be created during each and every audit. The archives are then subjected to laws that govern the record’s retention. Confidentiality principle safeguards the business from its rivals, competitors (Ruhnke, Pronobis & Michel, 2014, p. 34). This is because it helps the company in maintaining its competitive advantages and prohibits the invasion of its privacy. Unauthorized disclosures are highly discouraged while auditing to the third party. The information should not be publicized or disseminated unless the client willingly authorizes the dissemination of the accounting details. Access to the financial statement by a person not expressly permitted to get the information for a purpose that is legitimate must be prohibited. It is vital that there is no confidential information on the materiality of the company that is directly used by the auditors or indirectly by any third party for purposes that are both unethical and illegal (Ruhnke, Pronobis & Michel, 2014, p. 56). When such acts are prevented, the trust that is expected between the client and the auditor is preserved. Besides, when the records of the customer are maintained in a confidential way, the accountant can meet his or her responsibility for fostering a positive outlook of the business and a healthy business relationship. New Auditing Regulations and Materiality Disclosure This section of the paper will study some of the current rules used in auditing and how they influence of the disclosure of materiality in business. It is of importance to note that the regulations vary because companies are bound to differ as well. Auditing demands a high value of integrity (Eilifsen & Messier, 2014, p. 56). It shuns all malpractices that involve corruption. A proper verification process should be accurate and without any traces of deliberate doctoring of data to favor a person or an idea. Auditing that has high integrity is easily disseminated to people that are concerned or the stakeholders. On the other hand, if the materiality emanates from a poorly conducted auditing, then the data is best when not disclosed as it ruins the reputation of the company and the auditor. Auditing ought to be independent. Such audits are impeccable and faultless (Eilifsen & Messier, 2014 p 34). They are not influenced by any party. They are conducted by a neutral and transparent auditor who is trustworthy. The materiality level of business achieved by such an auditor is trusted and is quickly publicized since it does not register any malpractice. Materiality level from an auditing process can only be disclosed if only it complies with the auditing standards (Eilifsen & Messier, 2014 p 24). The validity of an audit is first determined by the kind of an auditor employed to carry out the work. Such an auditor should be a licensed professional. Other regulations are communicated to the various auditing bodies that are vast in many countries. They come up with the benchmarks of determining a good review from a bad one. For example, they are supposed to register standards of confidentiality and also possess utmost integrity. There exists other requirements that state how a firm is expected to audit its reports (Eilifsen & Messier, 2014, p. 67). There is also a requirement that the institution that monitors auditors who are registered on merit should ensure that the auditors operate while complying with the above set regulations. Some types of audits require that this kind of monitoring is to be independently conducted by the registered institutions. This will ensure which kind of materiality report can be disclosed to the public. The law also requires that the set rules regarding the type of audit work done should be written down by the body that is independent (Eilifsen & Messier, 2014, p. 34). Various institutions have ended up adopting the auditing, ethical standards and quality control from Auditing Practice Board. These standards are the International Standards of Auditing that operates in the UK and Ireland and precisely deal with conduct of each and every audit. International Standards on Quality Control is concerned with the entire quality control system that is often established by the licensed editor (Eilifsen & Messier, 2014, p. 156). The ethical standards set the entire moral obligations and demands of the registered accountants. Guidance of auditing enables the use of the regulations. In rare cases, there is often a lot of advice that can be used to merge it with regulations, and thus it is added in a separate section of the regulations and is also cross-referenced. There is a conviction that if the above laws and regulations are adhered to, they will boost the quality of the auditing process that is carried out (Eilifsen & Messier, 2014, p. 67). The laws and the regulations ensure that the auditor is a registered professional and that there is adherence to the rules and ethical standards. The materiality reports from such audits are deemed to be of high integrity and can be disclosed to the public and the stakeholders. Audits that do not adhere to the regulations are not trusted. The changes that have occurred in the auditing rules and laws are indeed good (Eilifsen & Messier, 2014, p. 100). This is because they aim at improving the entire process by ensuring that a good quality is upheld. The changes aim at eradicating vices in the process such as deliberate doctoring of data. The new laws provide that the confidentiality is maintained. Without these changes, then the materiality reports and related data after audits would be generating a lot of conflicts. In conclusion, the paper has defined materiality in auditing, gave a background of materiality. Materiality refers to the significance of audit that is determined by the quantity and quality of the misstatements. It includes all the amount that is quantifiable and also the impacts of this amount. Although the Financial Accounting Standards Board does not provide guidelines for determining materiality, the decisions made in are guided by the regulatory requirements and also the expectations of the public. theLooked at its significance, studied the secrecy in auditing and concluded by exploring the current regulations of auditing and how they influence the disclosure of materiality report. References Eilifsen, A & Messier, WF 2014, Materiality guidance of the major public accounting firms, Auditing: A Journal of Practice and Theory. Ruhnke, K, Pronobis, P & Michel, M 2014, Audit Materiality Disclosures and Credit Lending Decisions. Available from: SSRN 2460425. [1 Dec. 2014] Read More