The Critical Importance of Materiality in Auditing - Essay Example

Materiality in Auditing Table of Contents Introduction 3 The Critical Importance of Materiality in Auditing 3 The Uses of Materiality by Auditor as Secret 5 Academic Research about the Importance and Secrecy of Materiality 6 How Has Recent Audit Regulation, Particularly In Relation To Audit Reporting, Changed Audit Practice In Relation To the Disclosure of Materiality 8 Conclusion 9 References 11 Introduction This paper deals with the concept of ‘materiality’ in auditing and its importance within the context stated. The significance of materiality concept can be found rooted in the origination of auditing wherein the term ‘auditing’, refers to the verification of official accounts as well as records. In accordance, the term ‘materiality’ is described by the Council for International Accountancy Standards as it depends on the measurement of the evaluated component or on the error of the specific conditions. To be mentioned in this context, the auditor’s thought of materiality is found depended on the professional’s decisions and is influenced by the auditor’s awareness regarding the needs of financial statements to the operators. The auditor must therefore study the audit risks and aim at controlling the materiality level for the financial statement, based on which, the audit risk is evaluated by the management. It is in this context that materiality is required in the framework for the preparation of the financial statement. To be asserted in the simplest manner, the concept of materiality is applied by the auditor in planning as well as accomplishing the determined goals (IFAC, 2009). The Critical Importance of Materiality in Auditing The framework of financial reporting discusses the concept of materiality in the context of preparing and presenting the financial statement. This framework discusses materiality in various forms. For instance, the decision of materiality is prepared by the near conditions affected by the nature of the misstatement and in accordance, the decision of materiality is dependent on the attention of information of common finance. Contextually, it needs to be asserted that the term ‘materiality’ is applied by the auditor at the time of planning and implementing the audit process and also at the time of assessing the recognized misstatements on the overall procedure. The term ‘materiality’ thus addresses the significance of financial statement information to economic decision, developed by the operators based on the financial statement (IFAC, 2009). The impact of materiality on auditing process depends on the individual audit policies for challenging account balances as well as transactions. The committee of audit therefore needs to understand the confirmation of auditor with the concept of materiality at the group as well as at the component level. The idea of materiality forms a degree of flexibility in the financial reporting process. According to financial reporting standards commonly followed today, materiality adherence is important in an auditing process for three groups of stakeholders involving the organizers of financial statements, auditors and users as well as operators of financial statement. Contextually, the Auditing Standards (AUS) provide guidance regarding the auditor’s concern of materiality in planning the process and assessing the audit suggestion. The providing guidance is the calculation of materiality to design audit processes and selection strategies wherein the various factors, such as qualitative as well as quantitative elements are found to have their impacts on the calculation of auditor’s materiality. It is in this context that theorists argue that the auditor should reflect upon materiality at the time of determining nature, programming as well as level of audit procedures. Suggestively, the auditor also should reflect materiality in the financial report. Materiality may be influenced by the qualitative factors such as legal as well as regulatory requirements. It is therefore necessary for the auditors to accept that operators should have the knowledge of business as well, to account activities and determination to study the information about the financial statement, which should also appreciate that financial statements are organized, presented and audited to the levels of materiality. The regulations also specify that at the time of planning audit, auditors have to make the decision about the extent of the misstatement (Brennan & Gray, 2005). Therefore, from the above discussion, it can be stated that materiality is important in the context of auditing, as it helps upholding transparency and criticality of the auditing process, binding the various participants to cooperate with each other and in subsequence, ensuring adequate control within the reporting system. It is in this context that companies also need to provide a detailed account of the materiality aspect in its sustainability reports so that stakeholders are well informed of the transparency maintained by the company and additionally, investors’ confidence can be ensured at the utmost level such as in the case of BP and Tesco PLC (Tesco, 2014; BP, 2012). The Uses of Materiality by Auditor as Secret In recent years, the idea of materiality has been acknowledged as an essential measure in the context of auditing. The term has accordingly received much attention from regulators as well as community members of auditing. The concept of materiality is asserted to help the auditor to perform the process efficiently, which in turn depicts its critical uses in the context of auditing. However, it should be noted that materiality is not a process but a notion, through which the auditor can identify small errors or mistakes, when interpreting or evaluating the financial records. It often happens that due to the inadequate knowledge of the accountants regarding the treatment of a particular accounting variable, errors persist in their reporting mechanism, when the notion of materiality is used for the correction. Materiality is also used to determine the collective value of data. Studies have further revealed that materiality is also useful for collecting important information about the quality of the observing system. Materiality also improves the integrity within the auditing process by providing clear resources of addressing the mistakes (CDM, 2014). Materiality has been also observed as a significant information threshold that works for the benefit of information operators associated with the auditing process. At the time of financial audit, final decisions regarding materiality are made by practitioners of audit wherein the concept plays a fundamental role. It is worth mentioning in this context that materiality is addressed by auditors through several research activities. Notably, materiality is measured in audit two times – first, at the time of planning of audit, which is denoted as planning materiality and next, when concluding the audit process, which is termed as final materiality of audit. Planning materiality is essential for the purpose of risk assessment. Materiality is also important for designing the audit process as well as evaluating whether the financial statements are fair, complying with the recognized accounting principles (Brennan & Gray, 2005). For example, in the sustainability report of BP, the company highlights that materiality helps in determining the comparative significance of accounting issues witnessed by the company those are quite likely to have an influence on company financial reporting standards (BP, 2012). Materiality uses in identifying possible misstatements have also been agreed in the sustainability report of Tesco, which in turn justifies the above argued implications of imbibing the concept in financial reporting standards (Tesco, 2014). Academic Research about the Importance and Secrecy of Materiality In recent years, the idea of materiality is considered as the most serious elements in accounting proceedings. This particular notion not only intends to explain the theoretical investigation concerning the importance but also the secrecy of auditing processes. Materiality is important in planning as well as when implementing the auditing process. As already mentioned in the previous section, materiality is used in auditing for various purposes, such as to reduce risks associated with auditing. However, not a very many academic research has been performed on this issue, at least in the recent five years. Perhaps, the reason has been associated with the complexity of the term and its application procedure. According to Joldoş & et. al. (2010), materiality is considered in quantitative terms even though it is described as a notion. Beasley & Carcello (2008) further argued that the concept of materiality has become important in the community of financial accounting at the time of recent movements of financial reporting failures. Another way materiality can also defined is the ‘member interests’, basically indicating to the apprehension of the owners of financial capitals wherein the idea of materiality is fundamentally aimed to identify the misstatements or the chances of error in the financial statement (FRC, 2013). Furthermore, as argued by Zadek & Merme (2012), the purpose of performance materiality is not only involved in the mechanical calculation but it also involves in the exercise of professional judgements. Hence, it is strongly affected by the type of materiality depending on the understanding of the auditor. The influence of materiality of the audit work also depends on the audit plan developed prior to its instigation. Zadek & Merme (2012) were also of the view that Auditing Standard needs low level of component materiality than group materiality. Materiality also imposes a strong impact on the assessment of the unadjusted misstatements of financial accounting. From the academic research, it can be addressed that the objective of an auditor is to put on the idea of materiality in the planning as well as performing the audit. Performance materiality is also important for planning audit, especially when measuring the hazard of material misstatement as well as environment, judgment and extent of more audit procedures (Zadek & Merme, 2012). How Has Recent Audit Regulation, Particularly In Relation To Audit Reporting, Changed Audit Practice In Relation To the Disclosure of Materiality The objective of auditing is to confirm authority, regularity, productivity as well as effectiveness of financial management and public management through the measurement of ‘financial audit’, ‘compliance audit’ and ‘performance audit’. It is in this context that financial audit involves the preparation of financial statement. Accordingly, compliance audit involves laws, regulation, rules as well as various directions and the provisions of the composition, while performance audit involves programme, which functions effectively. It is one particular change that has been witnessed in the current phenomenon, especially when concerning audit-reporting practices in relation to the disclosure of materiality. The system has not only become more systematic and objective-oriented, but it has also enhanced in terms of transparency and effectiveness (Dayalan, 2007). The framework of financial report has been functioning in their planning of appropriate law and the International Financial Reporting Standards (IFRSs) is accepted by European Union, which further confirms better governmental intervention in the process as compared to the traditional era wherein a lacuna of vigilance was observed, giving rise to fraudulency to a substantial extent. Currently, the delegation process involved in auditing has also changed with a comparatively clearer description of the roles and responsibilities bestowed on the director as well as the auditor. The responsibility of an auditor is to audit the financial statements in agreement with the applicable laws as well as international financial reporting standards. It is in this regard that auditors need to deliberate the planning as well as perform auditing procedure for evaluating the appropriate result with respect to materiality (FRC, 2013). It is worth mentioning in this context that materiality today much widely accepted irrespective of it being challenging as it requires professional judgment on the conversation of the operators concerning the financial statement. However, besides the above mentioned limitations, the current auditing process also possesses certain limitations. For instance, in the currently applied process of auditing, there is no appropriate guidance found with regard to the implementation of the idea of materiality in its auditing practice. Professional decision is also an important tool for developing a fair financial report. It is in this context that auditors have been emphasizing proper accreditation of trained professionals, possessing knowledge about materiality to implement the multi-dimensional approach of auditing. In addition, in the current phenomenon, due to the different categories of auditing, the materiality levels also differ, which can in turn affect the degree of accuracy in the audited results. This in turn, mandates adequate knowledge among the auditors regarding the concept of materiality (McKee & Eilifsen, 2000). Conclusion From the above discussion, it can be concluded that materiality concept has its huge resemblance on the verification of financial reports to confirm transparency and accuracy in the interpretation. As an auditing idea, materiality depends on the measurement of evaluated components or on the misstatement as well as error of specific condition. It not only indicates towards the proper recording of financial statements but also ensures uniform interpretation of the data obtained at every level of the auditing process. The above discussion also reveals that the importance of materiality in the context of auditing is immense, wherein the idea is also used to ensure secrecy in auditing. Audit report and audit regulation also has a significant influence on the 21st century practices of auditing with due respect to the idea of materiality. The concept of materiality also provides significant information to the operators, which again assures accurate decision-making. Hence, it can be argued that materiality is an essential tool for planning as well as programming in audit procedures. Nevertheless, the influence of materiality in auditing procedures depends on the audit plan developed. Materiality also imposes significant impacts on the valuation of the unadjusted misstatements of financial accounting. References Beasley, M. S. & Carcello, J. V., 2008. GAAS Guide 2009: A Comprehensive Restatement of Standards for Auditing, Attestation, Compilation, and Review. CCH. Brennan, N & Gray, J. S., 2005. The Impact of Materiality: Accountings Best Kept Secret. Asian Academy of Management Journal of Accounting and Finance, Vol. 1, pp. 1-31. BP, 2012. Sustainability Review 2012. Group Reports. [Online] Available at: http://www.bp.com/content/dam/bp/pdf/sustainability/groupreports/BP_Sustainability_Review_2012.pdf [Accessed December 16, 2014]. CDM, 2014. Project Developer Forum Input on Materiality. Preamble, pp. 1-12. Dayalan, A., 2007. Regulations on Audit and Accounts. Comptroller and Auditor General of Audit, pp. 1-70. FRC, 2013. Audit Quality Thematic Review Materiality. Financial Reporting Council, pp. 1-24. IFAC, 2009. Materiality in Planning and Performing an Audit. International Standard on Auditing 320, pp. 321-329. Joldoş, A. M. & et. al., 2010. Pillars of the Audit Activity: Materiality and Audit Risk. Annals of the University of Petroşani, Economics, Vol. 10, No. 2, pp. 225-238. McKee, E. T. & Eilifsen, A., 2000. Current Materiality Guidance for Auditors. Foundation for Research in Economic and Business Administration, pp. 1-10. Tesco PLC, 2014. Annual Report and Financial Statements 2014. Reports. [Online] Available at: http://www.tescoplc.com/files/pdf/reports/ar14/download_annual_report.pdf [Accessed December 16, 2014]. Zadek, S & Merme, M., 2012. Redefining Materiality. Practice and Public Policy for Effective Corporate Reporting, pp. 1-40. Read More