Setting materiality levels

Setting materiality during audit is an important task for an auditor in order to pick a representative sample and also gives assurance that no major risks have been left undiscovered.

Any information that would influence the economic decision of the user of the financial statements is considered material. Materiality depends on the size of an item or error judged in the particular circumstance of its omission or misstatement.

An item may be material due to:

i) Its nature

Some transactions in a business by their very nature are considered to be material. For instance transactions relating to directors, their fees, loans and other benefits are considered material because directors can manipulate these transactions to the detriment of the company.

Other examples of material transactions are those relating to contracts between the business and third parties especially those not carried at arms length.

ii) Its value

Some items will be significant in the financial statement by virtue of their size. If a company purchased an asset whose value makes up 80% of the total assets in the balance sheet, omission or misstatement of that asset is considered material.

iii) Its impact

There are items in accounts which by chance have a significant impact on the financial statement. For instance a proposed journal entry which is not material in itself but could convert a profit into a loss or vice versa would be considered to be material. This is because the difference between a small profit and a small loss will be material to some users.

Materiality therefore cannot only be defined mathematically but it has to incorporate the qualitative aspects. These qualitative aspect deals with the failure to disclose relevant information as required by standards or legal provisions in a particular country. Materiality should be revised as audit progresses to reduce audit risk. Setting materiality is a significant process during audit.