S10: Materiality

Session Objectives To define materiality To define materiality To explain different types of materiality To explain different types of materiality Materiality for accounts based on cash or accrual system of accounting Materiality for accounts based on cash or accrual system of accounting

Definition A matter is, considered material if its omission or misstatement would reasonably influence the decision of an intended user of the audit report. A matter is, considered material if its omission or misstatement would reasonably influence the decision of an intended user of the audit report. Materiality should be considered by Audit when: Materiality should be considered by Audit when: determining the nature, timing and extent of audit procedures; and determining the nature, timing and extent of audit procedures; and evaluating the effect of misstatements. evaluating the effect of misstatements.

Types of Materiality Materiality by Value; Materiality by Value; Materiality by Nature; Materiality by Nature; Materiality by Context. Materiality by Context.

Materiality by Value The point where the total value of errors in an account becomes unacceptable to Audit, so that Audit would have to qualify the audit opinion, is called the materiality level of that account. The point where the total value of errors in an account becomes unacceptable to Audit, so that Audit would have to qualify the audit opinion, is called the materiality level of that account. The materiality thresholds depend on the basis of accounts and their sensitivity. The materiality thresholds depend on the basis of accounts and their sensitivity. While risk determines the likelihood of occurrence of the error, materiality determines the extent to which such errors can be tolerated. While risk determines the likelihood of occurrence of the error, materiality determines the extent to which such errors can be tolerated.

For Accounts Prepared on Cash Basis The materiality level is usually set at a percentage of gross expenditure, depending upon the sensitivity of the account The materiality level is usually set at a percentage of gross expenditure, depending upon the sensitivity of the account

For Accounts Prepared on Cash Basis (Contd.) Classification of Account Materiality Base Suggested Materiality as percentage Very sensitive Gross Receipts/ Expenditure ½ % Sensitive Gross Receipts/ Expenditure ½ % to 2% Not sensitive Gross Receipts/ Expenditure 2%

For Accounts Based on Accrual basis The materiality level is usually set at a percentage of the materiality base, depending upon the sensitivity of the account. The materiality level is usually set at a percentage of the materiality base, depending upon the sensitivity of the account.

For Accounts based on Accrual Basis (Contd.) Base figure for materiality Sensitivity of accounts Very sensitive Sensitive Not sensitive Normal net surplus 5% % 10% Gross income/ expenditure ½% ½ - 2% 2% Turnover (sales) ½% ½ - 2% 2% Total assets ½% ½ - 1% 1% Net assets 1% 1 – 2% 2%

Materiality by nature If the error affect a figure in the accounts which users expect to be stated with a high degree of accuracy or if the figure is likely to be of great interest to the users If the error affect a figure in the accounts which users expect to be stated with a high degree of accuracy or if the figure is likely to be of great interest to the users E.g. E.g. Surpluses and balances to be surrendered in Appropriation Accounts; Surpluses and balances to be surrendered in Appropriation Accounts; Items that need to be shown separately because of their exceptional nature; Items that need to be shown separately because of their exceptional nature; A capital expenditure is wrongly classified as revenue expenditure. A capital expenditure is wrongly classified as revenue expenditure.

Materiality by context If the error is material because of its implication on other aspects of the accounts If the error is material because of its implication on other aspects of the accounts E.g. E.g. due to a misstatement, the financial statements indicate that a department has savings when it has, in fact, exceeded its budget, it will become material by context as an excess would require regularisation by the Parliament under Article 115(1)(b) of the Constitution of India. due to a misstatement, the financial statements indicate that a department has savings when it has, in fact, exceeded its budget, it will become material by context as an excess would require regularisation by the Parliament under Article 115(1)(b) of the Constitution of India.

Materiality with Regard to Planning "Planning materiality" is primarily concerned with materiality by value. "Planning materiality" is primarily concerned with materiality by value. Audit calculates the highest level of "tolerable error" for the estimated accounts as a whole, that is the highest amount which would not distort the overall view of the accounts given to the addressee of the audit report. Audit calculates the highest level of "tolerable error" for the estimated accounts as a whole, that is the highest amount which would not distort the overall view of the accounts given to the addressee of the audit report.

Materiality with Regard to Planning (Contd.) The materiality of errors by nature and by context is a matter to be considered specifically at the end of the audit. The materiality of errors by nature and by context is a matter to be considered specifically at the end of the audit. At the planning stage, the possibility of such errors occurring should be recognised by ensuring that audit programmes include year-end procedures to detect them. At the planning stage, the possibility of such errors occurring should be recognised by ensuring that audit programmes include year-end procedures to detect them.

Materiality with Regard to Reporting Reporting materiality applies at the end of the audit when all errors are evaluated and viewed in relation to their known effects on the financial statements. Reporting materiality applies at the end of the audit when all errors are evaluated and viewed in relation to their known effects on the financial statements. Planning materiality may be taken as less than reporting materiality Planning materiality may be taken as less than reporting materiality

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