Explain the concept of Audit Materiality

Auditing and Assurance Revision Questions and Answers

As per NSA 320: Audit Materiality, the auditor should consider materiality and its relationship with audit risk when conducting an audit.

“Materiality” is defined in the Nepal Accounting Standards Board‟s “Framework for the Preparation and Presentation of Financial Statements” in the following terms:

“Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materially depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materially provides a threshold or cut-off point rather than being a primary qualitative characteristic, which information must have if it is to be useful.”

The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework. The assessment of what is material is a matter of professional judgment.

In designing the audit plan, the auditor establishes an acceptable materiality level so as to detect quantitatively material misstatements. However, both the amount (quantity) and nature (quality) of

misstatements need to be considered. Example of qualitative misstatements would be the inadequate of improper description of an accounting policy when it is likely that a user of the financial statements would be misled by the descriptions, and failure to disclose the breach of regulatory requirement when it is likely that the consequent imposition of regulatory restrictions will significantly impair operating capability.

The auditor needs to consider the possibility of misstatements of relatively small amounts that, cumulatively, could have a material effect on the financial statements. For example, an error in a month end procedure could be an indication of potential material misstatement if that error is repeated each month.

The auditor considers materiality at both the overall financial statement level and in relation to individual account balances, classes of transaction and disclosures. Materiality may be influenced by considerations such as legal and regulatory requirements and considerations relating to individual financial statement account balances and relationships. The process may result in different materiality levels depending on the aspect of the financial statements being considered.

Materiality should be considered by the auditor when:

(a) Determining the nature, timing and extent of audit procedure; and
(b) Evaluating the effect of misstatements.

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