Concept of Materiality Session Overview Concept of materiality; Materiality Judgment: Materiality Guidelines; Steps in determining materiality level; and

LEARNING OBJECTIVES Identify the users and the uses Determine appropriate materiality level; and Describe the factors affecting materiality level.

In my opinion, these financial statements Present fairly There is reasonable assurance Not materially misstated Implies

I am x % confident that the financial statements are correct within Rs. y x % is the overall level of assurance Rs. y is the materiality amount MATERIALITY AND AUDIT OPINION

DEFINITION OF MATERIALITY The magnitude or nature of a misstatement (including an omission) of financial information either individually or in the aggregate that, in the light of surrounding circumstances, makes it probable that the judgement of a reasonable person relying on the information would have been influenced or his decision affected, as a result of the misstatement. --IFAC Handbook

CONSIDERATIONS IN UNDERSTANDING MATERIALITY  Determined from users’ point of view;  Relates to maximum possible misstatements;  The misstatement includes all types of errors, frauds and other irregularities;  Not related to the amount used by management;  Auditor is concerned with the judgements of those who have "a reasonable knowledge of business and economic activities”;  Determined without reference to audit assurance.

MATERIALITY AT DIFFERENT STAGES Planning Decides what items to examine and whether to use sampling techniques; Calculate planning materiality. Execution Sample size on materiality; Drives additional procedures. Reporting Accumulated errors compared to materiality limit.

FACTORS AFFECTING MATERIALITY Three Main Factors: Amount of the item Nature of the item Context in which the item occurs Other Factors : Size of the entity, Nature of the misstatement, Entity-related factors, Environmental factors, Uncertainty, Cost-benefit considerations, and Characteristic of Accounting System & Policies.

MATERIALITY GUIDELINE - Cash basis accounting (gross expenditure/receipts) Classification of account Materiality as %age Very sensitive 1/2% Sensitive 1/2 - 2% Not sensitive 2% - Accruals accounting Base figure Very sensitive Sensitive Not sensitive Normal net surplus 5% % 10% Average Operating Income 5 % % 10 % Gross income/expenditure 1/2% 1/2 - 2% 2% Total assets 1/2% 1/2 - 1% 1% Working Capital 1% 1% - 2% 2% Equity 1% 1 - 2% 2%

STEPS IN DETERMINING MATERIALITY LEVEL Identify probable users; Identify important information; Review materiality guideline; Determine sensitivity of accounts; Determine highest % of base amount; Multiply the % by base amount and select lowest product.

A judgment of the maximum monetary misstatements that may exist in an account balance or a class of transactions without causing the financial statements to be materially misstated Tolerable Misstatements/Errors