Analysis of Materiality in Auditing - Essay Example

Materiality in Auditing Introduction: The idea and notion of materiality are necessary in order to conduct the auditing of financial ment. Materiality assures a particular standard to establish the acceptable level of indiscretions along with the risk involved in that. It determines the degree and course of audit work. Financial statements can seldom be perfect, even if some financial statements turn out to be accurate; there are some possibilities left that the user of the financial statements may require a particular level of accuracy. For that reason, the accuracy of the financial statements has automatically involved some extent of tolerance. This paper will highlight the complete aspect of materiality starting with the understanding of the concept of materiality; the paper discusses the significance of materiality in auditing followed with the secrecy level of materiality used by the auditor. The paper then reflects the topic in light of the previously done academic researches and the impact of recent audit regulation over the audit practices. Materiality in Auditing Materiality in Auditing is defined as the measure of the predictable outcome that results by the absence or presence of any item in the form of information. The impact of that may occur on the validity and accuracy of the statements. The materiality is gauged in relation with its inherent nature, it value, its influence (impact), its usage value and the circumstances associated with its occurrence. It has been said that the materiality is related with the importance of the transaction, balances and the errors in the financial statements. Importance of materiality in Auditing: The materiality reflects the significance of a lapse or any mistaken presentation of accountancy information, especially that information that develops the justification for the person who is accountable for any change in the information. The materiality also represents the substantiality in the report in terms of identifying the omission, errors or any mistakes in the accounts. Further, it shows a comprehensive authenticity and accuracy of the performance and financial position of an entity (Moraru, & Dumitru, 2012). The materiality in auditing determine the internal control deficiencies, it helps in the assessment of the impact of each deficiency on the fairness of financial statement presentation. It also figures out and reports the important control deficiencies or any weaknesses in the material to the audit committee of the board of directors and also to the independent auditor of the company. The normal process of materiality evaluation reviews each item on an individual level followed with the review of all items on the aggregate level in relation with each company’s working materiality levels. The purpose of this is to adjust and fix the financial statements. The materiality in auditing reflects the variances in the stated information from the original estimates. It helps in identifying the fraud prevailing in any entity and reduces the factor of risk for future. The aspect of materiality in auditing is of great importance is related with the overall transaction, the amount involved and the discrepancy associated with the concerned matter. The qualitative aspect of materiality depicts the idea that any exception in the information is of great importance to the user of that financial information. It helps in assessing the risk particularly material risks (Vorhies, 2005). The importance of materiality is only associated with the corporate entities of private sector. It has a significant role in the governmental auditing. It works in the opinion unit of the government departments. The opinion units’ involves the activities associated with business, governments activities, and in general and major funds of government. The materiality reflects the tolerable level of indiscretion and irregularity in the financial information along with the determination of the direction and extends of the audit work (Brennan, & Gray, 2005). Secrecy level of materiality used by the auditors: The level of secrecy is very much associated with the concept of materiality, and it is great importance by the use of auditors. This is because of the fact that the financial information involved requires confidentially, and any indiscretion may result in decreasing the value and substantiality of the information. The connotations of secrecy are link with the form of ownership that has the potential to affect the financials in the auditing. This can be witnessed at the government level that often have a preference over those auditors that can maintain the confidentiality of the materiality in auditing of several financial reports in order to maintain the governments political activities and concerns. This reflects that the confidentially and secrecy of materiality can lead auditors to perform an efficient and valuable role in protecting the government concerns over the interest of states (Ndreca, 2013). Secrecy of the material in the auditing is prevailing in order to maintain the confidentiality of the important financial information. Opposite of which may result in damaging of any entity’s image. However, despite the fact, secrecy may lead the hiding of relevant information from the investors and other stakeholders of the company. The subject immensely impacted the reputation of Enron and question over the secrecy of the substantial material (Ndreca, 2013). However at Tesco, the annual report of financial statements highlighted the aspect of materiality and mentions their overview on the approach of auditing. In the annual report of 2014, Tesco reveals that they have kept a certain threshold for the materiality and stated the amount and percentage associated with that (Tesco, 2014) Importance and secrecy of materiality in light of previous research studies: In the academic literature, the subject of materiality has gained a great attention and the entire literature over the matter has parsed into four distinct areas. These includes a. Determination of materiality for the audit engagement b. Theory of Auditing c. Experiments d. Field tests According to Ndreca (2013), the information can be termed as material if the wrong appearance and failure of that information have a potential to influence and persuade the economic decisions prepared on the foundation of financial statements. He has argued that the there is a relationship between materiality and risk associated with auditing. Materiality is the magnitude measurement whereas the risk is a measurement of uncertainty. Further, materiality also involves the utilization of a proficient system, which determines its preliminary level and underpins the consequences of the statute under any changing circumstances (Steinbart, 1987). It also involves the advancement of a theoretic perspective that can be formulated in indecision over the interactions of a manager and auditor (Patterson and Smith, 2003). It has been said that the determination and fortitude of materiality is the substantial aspect of professional judgment. It is greatly influenced by the perception of the auditors about the financial information needs of those who utilize the financial statements (Financial Reporting Council, 2013). Vorihes (2005), over the issue of materiality, expresses that review of the materiality of the financial statement reveals the misstatements that are unrecorded and uncorrected. According to him the errors can fall into three different ranges; these are consequential, inconsequential and material. Further, he highlighted that the significance of materiality is seen in controlling the deficiency of reporting the information. Further, it has been studied that the concept of materiality is applicable to a particular set of financial statements that are issued in the specific area of GAAP (Kearns, n.d.). The quality of audit is seemed to be a significant factor that ensure the reliability and integrity of corporate governance and the overall process of financial reporting (Wan Abdullah et al., 2008). In this domain, the quality of the audit has an effect over the capability of the auditor in order to identify the material misstatements in the financial statements of the company. It also affects the willingness of the auditor to highlight the mistreatments (Zhou, 2012) Iselin and Iskander (2000) state that the threshold of materially in auditing creates a divisional line between immaterial and material information. Past researches (for instance, Boatsman & Robertson, 1974; Messier, 1983; Iskandar & Iselin, 1999) reflect that there was a lack of agreement in auditors about the degree and extent of disclosure of materiality Impact of recent audit regulation (in relation to audit reporting) over Audit practice (in relation to disclosure of materiality): The legal accounting regulations and the professional accounting regulations differentiate between the immaterial and material items in the financial information of the companies and pertain several different rule, regulations, requirements and approaches that deal with these two categories. This differentiation is particularly very significant in identifying that what is particularly supposed to be disclosed and what is not supposed to be disclosed. However, there are accounting standards that want organizations to disclose their accounting policies in order to get the information about the material item, these may include the material reliant liabilities (Brennan, & Gray, 2005) Among several different suggested regulations for the improvement of the auditing regulations, there is a projected regulation that highlights the premising of the replacement of the auditing firms by facilitating the public interest entities. With that there are many other recommendations that have been proposed in order to improve the accountability in auditing and to increasing the degree of transparency by the auditing team (European Commissions, 2014). Further, Messier, & Boh, (2002) stated that the disclosures expand with magnitude of the loss that is conditional in nature. The sole rationale behind the disclosures is to make the financial statements of the companies more explicable and comprehensible for the users. The implications of the disclosure also related with the auditors. An average careful investor is always permitted to aware by the level of materiality used by the auditors. It has been emphasized by many researchers to extend the degree of disclosure requirements and it must incorporate the information about the levels of materiality in order to improve the transparency of auditing and accounting (Brennan and Gray, 2005). Further in section 320 of ISA, it has been mentioned that an auditor must have to consider every aspect of materiality. This should be in terms of the overall level of financial statement and also in the relation to the account balances of individuals, disclosures and different classes of individuals. Such regulatory measures highlight the issue of different levels of materiality established by the auditors by taking into consideration the factors of different legal or regulatory requirements, account balances, and individual statements of financials of the companies (McKee, & Eilifsen, 2000). Conclusion: With the above presented thorough analysis over the materiality in auditing, it has been concluded that it is indeed true that the term ‘material’ is of critical importance in the auditing context” (Porter et al., 2014, p.73). The statement is backed by the supported argument which highlights the significance of materiality in the auditing of firms. With the establishment of materiality, comes the substantiality of the reports; as it adds value to the result of the audits. The materiality helps in identifying the errors, mistakes and any omission of the financial information. With that, it has been observed that the auditors maintain a certain level of secrecy about the materiality. There are several aspects of secrecy in materiality. Sometimes, many companies have found in maintaining the secrecy and are willing not to disclose the confidential financial information of the company. In due course, the government departments also expect auditors to keep the secrecy of material. Hence, it can be said that the Materiality levels are more secret than the Coca-Cola formula” (Mock et al., 2009, p.4). Several previous researchers have highlighted the importance of materiality in auditing on the basis of their research studies and elaborated the concept of materiality by presenting its different dimensions in auditing. Now with the rapid evolving role of auditors and auditing firms it is of great importance that the proper filing of financial information must take place in the financial statements of the companies. This will help the stakeholders of the company along with the investors to get a real and accurate picture of the company’s financial position. References Boatsman, J. and Robertson, C. (1974). Policy- Capturing on Selected Materiality Judgments. The Accounting Review, vol. 49, pp. 343-44. Brennan, N., & Gray, S. J. (2005). The impact of materiality: accounting’s best kept secret. Asian Academy Of Management Journal Of Accounting And Finance, Available from http://www.esma.europa.eu/system/files/brennan-gray_materiality_paper.pdf [Accessed 15 December 2014] European Commissions. (2014). European Parliament backs Commission proposals on new rules to improve the quality of statutory audit. Available from http://europa.eu/rapid/press-release_STATEMENT-14-104_en.htm?locale=en [Accessed 15 December 2014] Financial Reporting Council. (2013). Audit Quality Thematic Review: Materiality. Available from https://frc.org.uk/Our-Work/Publications/Audit-Quality-Review/Audit-Quality-Thematic-Review-Materiality.pdf [Accessed 15 December 2014] Iselin, E. R., & Iskandar, T. M. (2000). Auditors’recognition And Disclosure Materiality Thresholds: Their Magnitude And The Effects Of Industry. The British Accounting Review, vol. 32, no. 3, pp. 289-309. Iskandar, T. M., & Iselin, E. R. (1999, September). A review of materiality research. In Accounting Forum (Vol. 23, No. 3, pp. 209-239). Blackwell Publishers Ltd. Kearns, F. (n.d.). Materiality & the Audit Report. Available from https://ritdml.rit.edu/bitstream/handle/1850/8790/FKearnsArticle2007.pdf?sequence=1 [Accessed 15 December 2014] McKee, T. E., & Eilifsen, A. (2000). Current materiality guidance for auditors. Available from http://brage.bibsys.no/xmlui/bitstream/handle/11250/166032/A51_00.pdf?sequence=1 [Accessed 15 December 2014] Messier, W. F. (1983). The effect of experience and firm type on materiality/disclosure judgments. Journal of Accounting Research, pp. 611-618. Messier, W. F., & Boh, M. (2002). Auditing and assurance services in Malaysia. McGraw-Hill. Moraru, M., & Dumitru, F. (2012). The importance of materiality in audit.Anale. Seria Stiinte Economice. Timisoara, vol. 18, pp. 266-272. Ndreca, P. (2013). Materiality-An Important Method And Technique For The Financial Auditing. European Scientific Journal, vol. 9, no. 13. Tesco. (2014). Annual Report and Financial Statements 2014. Available from http://www.tescoplc.com/files/pdf/reports/ar14/download_annual_report.pdf [Accessed 15 December 2014] Vorhies, J. (2005). The New Importance of Materiality. Journal of Accountancy, Available from http://www.journalofaccountancy.com/Issues/2005/May/TheNewImportanceOfMateriality.htm [Accessed 15 December 2014] Zhou, Y. (2012). Government audit materiality (part two): conceptual and practical implications of a qualitative materiality framework: seven case studies and a comparative conceptual work. International Journal of Economics and Finance, vol. 4, no. 2, pp. 85. Read More