S10: MaterialityS10: Materiality

Session ObjectivesSession Objectives

To define materialityTo define materiality To explain different types of To explain different types of

materialitymateriality Materiality for accounts based Materiality for accounts based

on cash or accrual system of on cash or accrual system of accountingaccounting

DefinitionDefinition A matter is, considered material if A matter is, considered material if

its omission or misstatement would its omission or misstatement would reasonably influence the decision of reasonably influence the decision of an intended user of the audit an intended user of the audit report.report.

Materiality should be considered by Materiality should be considered by Audit when:Audit when: determining the nature, timing and determining the nature, timing and

extent of audit procedures; andextent of audit procedures; and evaluating the effect of misstatements.evaluating the effect of misstatements.

Types of MaterialityTypes of Materiality

Materiality by Value;Materiality by Value; Materiality by Nature; Materiality by Nature; Materiality by Context.Materiality by Context.

Materiality by ValueMateriality by Value The point where The point where the total value of errorsthe total value of errors in in

an account becomes unacceptable to Audit, so an account becomes unacceptable to Audit, so that Audit would have to qualify the audit that Audit would have to qualify the audit opinion, is called the materiality level of that opinion, is called the materiality level of that account. account.

The materiality thresholds depend on the The materiality thresholds depend on the basis of accounts and their sensitivity. basis of accounts and their sensitivity.

While risk determines the likelihood of While risk determines the likelihood of occurrence of the error, materiality occurrence of the error, materiality determines the extent to which such errors determines the extent to which such errors can be tolerated.can be tolerated.

For Accounts Prepared For Accounts Prepared on Cash Basison Cash Basis

The materiality level is The materiality level is usually set at a percentage usually set at a percentage of gross expenditure, of gross expenditure, depending upon the depending upon the sensitivity of the accountsensitivity of the account

For Accounts Prepared on For Accounts Prepared on Cash Basis (Contd.)Cash Basis (Contd.)

Classification Classification of Accountof Account

Materiality Materiality BaseBase

Suggested Suggested Materiality as Materiality as percentagepercentage

Very sensitiveVery sensitive Gross Gross Receipts/ Receipts/ ExpenditureExpenditure

½ %½ %

SensitiveSensitive Gross Gross Receipts/ Receipts/ ExpenditureExpenditure

½ %½ % to 2% to 2%

Not sensitiveNot sensitive Gross Gross Receipts/ Receipts/ ExpenditureExpenditure

2%2%

For Accounts Based For Accounts Based on Accrual basison Accrual basis

The materiality level is The materiality level is usually set at a percentage of usually set at a percentage of the materiality base, the materiality base, depending upon the depending upon the sensitivity of the account.sensitivity of the account.

For Accounts based on For Accounts based on Accrual Basis (Contd.)Accrual Basis (Contd.)

Base figure Base figure for for materialitymateriality

Sensitivity of accountsSensitivity of accounts

Very Very sensitivesensitive

SensitiveSensitive Not Not sensitivesensitive

Normal net Normal net surplussurplus

5%5% 5 - 10%5 - 10% 10%10%

Gross Gross income/ income/ expenditureexpenditure

½%½% ½ - 2%½ - 2% 2%2%

Turnover Turnover (sales)(sales)

½%½% ½ - 2%½ - 2% 2%2%

Total assetsTotal assets ½%½% ½ - 1%½ - 1% 1%1%

Net assetsNet assets 1%1% 1 – 2%1 – 2% 2%2%

Materiality by natureMateriality by nature

If the error affect a figure in the If the error affect a figure in the accounts which users expect to be accounts which users expect to be stated with a high degree of accuracy stated with a high degree of accuracy or if the figure is likely to be of great or if the figure is likely to be of great interest to the users interest to the users

E.g.E.g. Surpluses and balances to be surrendered Surpluses and balances to be surrendered

in Appropriation Accounts; in Appropriation Accounts; Items that need to be shown separately Items that need to be shown separately

because of their exceptional nature;because of their exceptional nature; A capital expenditure is wrongly classified A capital expenditure is wrongly classified

as revenue expenditure.as revenue expenditure.

Materiality by contextMateriality by context

If the error is material because of its If the error is material because of its implication on other aspects of the implication on other aspects of the accountsaccounts

E.g. E.g. due to a misstatement, the financial due to a misstatement, the financial

statements indicate that a department has statements indicate that a department has savings when it has, in fact, exceeded its savings when it has, in fact, exceeded its budget, it will become material by context budget, it will become material by context as an excess would require regularisation as an excess would require regularisation by the Parliament under Article 115(1)(b) of by the Parliament under Article 115(1)(b) of the Constitution of India. the Constitution of India.

Materiality with Regard to Materiality with Regard to PlanningPlanning

"Planning materiality" is primarily "Planning materiality" is primarily concerned with materiality by value. concerned with materiality by value.

Audit calculates the highest level of Audit calculates the highest level of "tolerable error" for the estimated "tolerable error" for the estimated accounts as a whole, that is the highest accounts as a whole, that is the highest amount which would not distort the amount which would not distort the overall view of the accounts given to overall view of the accounts given to the addressee of the audit reportthe addressee of the audit report. .

Materiality with Regard to Materiality with Regard to Planning (Contd.)Planning (Contd.)

The materiality ofThe materiality of errors by nature errors by nature and by context is a matter to be and by context is a matter to be considered specifically at the end of considered specifically at the end of the audit.the audit.

At the planning stage, the possibility At the planning stage, the possibility of such errors occurring should be of such errors occurring should be recognised by ensuring that audit recognised by ensuring that audit programmes include year-end programmes include year-end procedures to detect them.procedures to detect them.

Materiality with Regard to Materiality with Regard to ReportingReporting

Reporting materiality applies at Reporting materiality applies at the end of the audit when all the end of the audit when all errors are evaluated and viewed errors are evaluated and viewed in relation to their known effects in relation to their known effects on the financial statements. on the financial statements.

Planning materiality may be taken Planning materiality may be taken as less than reporting materialityas less than reporting materiality

Case StudyCase Study