Materiality in Auditing - Essay Example

Materiality in Auditing Table of Contents Introduction 3 Critical Importance of Materiality in Auditing 3 Reduces Mis ments or Errors 4 IncreasesInternal Control 4 Accounting Estimates 5 Reduction of Fraud 5 Reasons for Materiality Levels Used by Auditors been Secret 6 Academic Research regarding the Importance and Secrecy of Materiality 7 Importance 7 Secrecy 8 Audit Regulation in Relation to Audit Reporting 8 Changed Audit Practice in Relation to the Disclosure of Materiality 9 Effectiveness of Changed Audit Practice 10 Conclusion 11 References 12 Bibliography 15 Introduction Materiality in auditing denotes the effect of the amounts presented in a financial statement in a different approach. It is extremely important from the perspective of an organisation for its greater economic development. Materiality in auditing is important considering the effectiveness of decision-making procedure of an organisation. In this regard, for establishing an effective auditing practice within a firm, certain regulations need to be followed and implemented. These regulations are established by several accounting bodies that encompass the Institute of Chartered Accountants in England and Wales (ICAEW) and the Institute of Chartered Accountants in Ireland operating as Chartered Accountants Ireland (ICAI) among others (Gupta, 2004). Contextually, the prime objective of the essay is to undertake a comprehensive study regarding materiality in auditing. In this regard, the critical importance of materiality in auditing is highlighted. Moreover, the essay would also highlight the reasons for keeping the materiality levels secret. Critical Importance of Materiality in Auditing In several nations of the world, implementation of certain rules and regulations regarding the materiality in auditing is witnessed. The implementation of such regulations also signifies the critical importance of materiality in auditing. The following factors eventually provide a better understanding about the importance of materiality in auditing: Reduces Misstatements or Errors The major importance of materiality in auditing is the increase in the credibility of the financial reports. The credibility of the financial reports is of extreme importance from the perspective of a firm. In this regard, the other significance of materiality in auditing lays in diminishing misstatements or errors. It will be vital to mention that that there exist two areas based on which the credibility of auditing increases through materiality. One of such areas is recognised to be the reduction in incorrect recording of financial amounts and the other area is lessening the preparation of incomplete financial statements that lack certain financial amounts (Beasley & Carcello, 2008). Increases Internal Control Materiality in auditing significantly increases the internal control of a firm. This is also of extreme importance from the perspective of a firm. In this regard, any failure internal control of an audit firm is regarded as control deficiency. These control deficiencies generally erupt from the failure of control in design and operations of a firm. A design failure generally occurs while the management has not ascertained any internal control, resulting in restricting towards obtaining predetermined objectives. Moreover, operation failure generally occurs when appropriate and adequately designed controls are not operated efficiently. This operation failure also restricts the firms to gain their respective predetermined objectives. In this regard, materiality in auditing plays a decisive role in minimising the possibility of having failures of internal control in design and operations. Materiality in auditing provides a rigid structure to the firms in terms of increasing the credibility of the financial statements and reports. This subsequently enables the firms to hold stronger internal control (Ramos, 2006). Accounting Estimates It is worth mentioning that adequate as well as appropriate estimation of financial condition of a firm is one of the prime facets of materiality in auditing. This is extremely important from the perspective of a firm considering the feasibility of its future objectives. A firm, which possesses materiality in auditing, strongly relies in the credibility of the accounting and financial reports. This subsequently supports the firm to set its goals and objectives accordingly. Moreover, the estimation of financial conditions also supports the firms to undertake several decisions that generate significant benefits (Henderson, 2008). Reduction of Fraud It is often observed that with the increase in the materiality in auditing, the credibility of financial and accounting reports also get increased by a considerable level. This eventually leads towards reduction in the possibility of raising any fraud within a firm. The firms, owing to the maintenance of materiality in auditing, hold a rigid internal control regarding each and every operational aspect. This certainly led towards higher control regarding the elimination of fraudulent activities that might occur within the firms (Vohries, 2005). In order to support the argument about the importance of materiality lay in the auditing context, the example of Coca-Cola India Private Limited (CCIPL) can be taken into concern. It can be apparently observed that this company has adopted a structured materiality matrix based on “Me-We-World” approach for growing its business extensively. In the context of auditing, the significance of materiality linked with CCIPL can be determined in the form of detecting any sort of potential misconduct and complying with varied types of accounting policies with the aim of ensuring the conduct of ethical practices (Khetan, 2012). Reasons for Materiality Levels Used by Auditors been Secret It is quite important for a firm to preserve secrecy with regards to the materiality levels used by auditors. The prime reason for materiality levels used by auditors been kept secret is to preserve the confidentiality of internal control of the firm. In this regard, there are several strategies applied by a firm considering the preparation of auditing report of a firm. It is thus observed that if the audit reports of a firm are revealed in an open manner, then the competitors would be able to understand the internal strengths of the firm. This would certainly encourage the competitors to establish strategies that are unfavourable to the sustainability of such firms whose materiality levels are not kept as secret. Moreover, it can also be apparently observed that through the disclosure of the audit reports of a firm, the competitors are able to copy its internal strategies. This coping of the internal strategies certainly leads towards lowering the competitive position of such firms by a considerable level. In this modern era of competitive business environment, it is quite obvious that none of the firms would like to lose competitive advantage. Hence, preserving the secrecy of the materiality levels used by audit firms is deemed to be quite vital for the modern firms (Mock & et. al., 2009). In this regard, Mock & et. al. (2009) stated that “Materiality levels are more secret than the Coca Cola formula.” In order to support the above stated argument, the example of Coca-Cola has been considered. The statement signifies the level of secrecy of materiality in auditing, which is extremely high as comparison to the secrecy of Coca Cola formula. In this regard, it is important to note that there have been several attempts to disclose the formula of Coca Cola product, but none of them were successful. The aforesaid authors, by comparing the secrecy of materiality in auditing with the secrecy of Coca Cola formula, magnified the importance of the same in real world scenario. However, as per the belief of several researchers, the formula of Coca Cola product contains several ingredients like coca leaf and kola nut among others, which denotes higher materiality level persistent in product development procedure of the company (Mock & et. al., 2009). Academic Research regarding the Importance and Secrecy of Materiality Importance Identifiably, several researches have been conducted that revealed the importance and secrecy of materiality in auditing for a firm. In this regard, according to Keune & Johnstone (2012), one of the major attractive facets of materiality in auditing lay in the context of reducing fraudulent practices in the internal process of the firm. The reduction in this particular aspect may assist the modern business corporations towards maintaining business ethics by a considerable extent altogether. Moreover, according to Moroney & Trotman (2012), the significance of materiality in auditing lay in other different aspects. One of such aspects is about increasing the internal control of a firm by ensuring the maintenance of higher materiality in auditing. Besides, as per the viewpoints of Whittington & Delaney (2012), the materiality in auditing supports a firm in setting its objectives and visions. It also supports the management of a firm to undergo effective decision making with regards to the desired organisational objectives. Secrecy Similar to the importance of materiality in auditing, several researches have also been conducted about the secrecy of materiality in this field. In this regard, according to Rittenberg & et. al. (2011), one of the major reasons for the secrecy of materiality is preserving the strategies of the internal control of a firm. In this regard, each and every organisation has certain unique strategies regarding internal control. Moreover, firms possess certain visions and missions by taking into concern the prevailing financial conditions. The disclosure of the materiality in auditing would lead other organisations to gain competitive advantages. Thus, it is extremely important from the perspective of a firm to preserve its secrecy regarding materiality in auditing. Audit Regulation in Relation to Audit Reporting In the United Kingdom, there are certain audit regulations in relation to audit reporting that proved to be highly effective in preserving business ethics. In this regard, the Institute of Chartered Accountants in England and Wales (ICAEW) and The Institute of Chartered Accountants in Ireland operating as Chartered Accountants Ireland (ICAI) among others are held responsible for implementing effective audit regulations. In this regard, an audit committee must contain at least 3 non–executive and independent directors. Moreover, one of the regulations as forwarded by ICAEW is that the audit committee may order the affected party in contributing a cost for the review. Another regulation can be ascertained as that none of the members of the affected party have the right to attend the registration committee meeting. Moreover, one of the important regulations in this regard can be traced as improving the effectiveness of internal audit. The periodic review control and risk management with regards to audit reporting is of extreme importance. This is regarded as one of the major regulations laid down by ICAEW and ICAI. Moreover, another important regulation can be determined as proper monitoring of integrity of financial statements and reports prepare by the audit committee. Furthermore, another regulation laid down by ICAEW is providing independence to the external auditors for following and preserving an effective audit process. Furthermore, there also exist certain regulations concerning the implementation of adequate policies by the audit committee so that the external auditors are also engaged in providing non-audit services to the firms (Delaney, 2007). Changed Audit Practice in Relation to the Disclosure of Materiality Evidences reveal certain changes in the audit practices with regards to the disclosure of materiality in auditing. One of such changes can be ascertained in relation to the independency level of the external auditors. The independence of external auditors is of extreme importance considering the increase in the credibility in the financial reports. Moreover, it is also important that the disclosure of the materiality in auditing is also of greater importance for undertaking economic policies by the government. Furthermore, the independence provided to the external auditors also establishes proper allocation of valuable resources of a firm. Besides providing independence to the external auditors, there is also another audit practice that has been observed with regards to disclosure of materiality. This is the non-audit services provide by the external auditors. Although, there have been several benefits of the non-audit services deliver by the external auditors, still there are arguments in favouring these services. In this regard, this certainly creates issues regarding the reliability of the clients towards any firm (Gul, 2014). Effectiveness of Changed Audit Practice The changed practice in auditing has been highly effective in several firms of the world. The change with regards to independence and non–audit services of the external auditors has significantly benefited firms as well as the economy of a nation. In this regard, it is observed that through these changes, the ethics in the business process gets exaggerated. The implication of ethics within an organisation leads towards increasing employee morale. This increase in employee morale implies greater augmentation in the level of employee motivation. The high motivation level within an organisation not only magnifies job satisfaction, but also develops the overall performance of the organisations. It is also observed that through the aforementioned changes and regulations, the evidences of fraudulence within an organisation get reduced. This is of extreme importance from the perspective of an organisation in order to attain its desired goals and objectives within a predefined timeframe. Furthermore, it is also important to note that the aforementioned changes and regulations with regards to auditing are of greater importance from an economic development perspective. It is projected that the respective government of a nation through gaining appropriate knowledge about the financial conditions of all the firms would be able to reap several significant benefits. Thus, considering appropriate gathered data, the respective governments will be able to implement strategic decisions regarding the growth and development of the nations effectively (Frias & et. al., 2012). Conclusion From the above analysis and discussion, it has been quite evident that the materiality is of extreme importance for the firms in the field of accounting. Moreover, it can be found that there are certain firms that prefer to preserve secrecy with regards to materiality levels persisting in auditing field. This is done prominently to gain superior competitive advantages. Notably, there have been certain rules and regulations to be followed about determining materiality in auditing field. These regulations are majorly for the purpose of establishing an ethical auditing process within a firm and also paving towards making broader development of an economy. Thus, it is quite important to assert that for the growth and development of an economy, each and every nation of this world should adhere to the regulations regarding materiality in auditing. Furthermore, the nations should also follow such regulations for encouraging ethical audit practicing. References Beasley, M. S. & Carcello, J. V., 2008. GAAS Guide 2009: A Comprehensive Restatement of Standards for Auditing, Attestation, Compilation, and Review. CCH. Delaney P. R., 2007. Wiley CPA Examination Review 2007-2008, Problems and Solutions. John Wiley & Sons. Frias & et. al., 2012. Textbook in Auditing Theory. Goodwill Trading Co., Inc. Gul, F. A., 2014. Hong Kong Auditing: Economic Theory & Practice (Third Edition). City University of HK Press. Gupta, 2004. Contemporary Auditing. Tata McGraw-Hill Education. Henderson, P., 2008. Top Auditing Issues for 2009 Cpe Course. CCH. Keune, M. B. & Johnstone, K. M., 2012. Materiality Judgments and the Resolution of Detected Misstatements: The Role of Managers, Auditors, and Audit Committees. American Accounting Association, Vol. 87, Iss. 5, pp. 1641-1677. Khetan, N., 2012. Governance and Ethical Conduct. Coca-Cola India Sustainability Report 2012. [Online] Available at: http://www.coca-colaindia.com/CMS/Asset/environment_Report_2012.pdf [Accessed December 14, 2014]. Mock, T. J. & et. al., 2009. A Summary Report to be discussed at the Accounting Research Forum Leventhal School of Accounting University of Southern California. Auditing Standards Board and the International Auditing and Assurance Standards Board. Moroney, R. & Trotman, K. T., 2012. Differences in Auditors’ Materiality Assessments When Auditing Financial and Non-Financial Reports. Monash University. [Online] Available at: http://mams.rmit.edu.au/xhc5rqb7lhvw1.pdf [Accessed December 09, 2014]. Ramos, M. J., 2006. Wiley Practitioners Guide to GAAS 2006: Covering all SASs, SSAEs, SSARSs, and Interpretations. John Wiley & Sons. Rittenberg, L. & et. al., 2011. Auditing: A Business Risk Approach. Cengage Learning. Vohries, J. B., 2005. The New Importance of Materiality. Journal of Accountancy. [Online] Available at: http://www.journalofaccountancy.com/Issues/2005/May/TheNewImportanceOfMateriality.htm [Accessed December 09, 2014]. Whittington, O. R. & Delaney, P. R., 2012. Wiley CPA Exam Review 2012, Auditing and Attestation. John Wiley & Sons. Bibliography Batra, G. S., 1998. Auditing and Contemporary Accounting: New Horizons. Deep and Deep Publications. Bagshaw, K. & Selwood, J., 2014. Core Auditing Standards for Practitioners. John Wiley & Sons. Matthews, D., 2006. 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