Materiality (auditing) - Materiality As An Empirically Discovered Amount

Materiality As An Empirically Discovered Amount

Defining materiality alternately or otherwise,It is an expression of relative significance or importance of a particular matter in context to financial statements.(by Mortian 2011)

Alternately, one could argue that rather than being a dollar amount developed by the auditor based on their professional judgement, materiality is a market phenomenon that must be discovered by the auditor through research activities. This interpretation is supported by the phrase "is material if its omission or misstatement could influence the economic decisions of financial statement users". Thus, the auditor must determine what amount does influence the decisions of financial statement users via a variety of methods, and potentially average those methods in an attempt to estimate the real monetary amount of materiality (which can never be known since it is simply the collective sentiment of all investors, creditors, managers, and regulators).

Auditors could conceivably ask the audit committee or board of directors to determine materiality since these groups represent investors and creditors. Another approach might involve developing a sensitivity analysis model that attempts to measure changes in a company's stock price as a function of changes in financial performance - thus revealing what monetary amounts investors perceive to be actionable. In contrast, materiality may be an amount that is important for regulators in some industries. For example, if a regulatory body has declared it is only interested in violations exceeding a particular monetary amount, this number may form the basis of determining materiality.

For an entity with a relatively small number of creditors, investors, managers and regulators, the auditor can simply determine materiality with direct inquiries made to these constituencies. Averaging the materiality amounts provided by these constituencies may lead to audit efficiency, however using the smallest materiality amount noted during the inquiry process ensures that even the most conservative constituent is satisfied with the relevance of the audit findings.

Qualitative materiality
Materiality also has a qualitative aspect. This refers to the notion that a misstatement or omission of information can be significant to the users of the financial statements due to the nature, rather than the size, thereof. An example is an important disclosure that is omitted from the financial statements.

Where materiality fits into the audit process
Materiality is quantified and considered twice during the audit process: first during the planning phase of the audit (when it is referred to as "planning materiality"), and second during the concluding phase of the audit (when it is referred to as "final materiality").

The assessment of planning materiality is required for risk assessment purposes (simply put: a material mistake holds risk for the auditor and the auditor should plan and perform the audit in such a way that he is likely to detect such mistakes). At this point in the audit the auditor has not performed any testing as yet. Hence, if he opts to quantify materiality using one of the common rules listed above, he has to apply the percentage to financial information that does not relate to the period under audit (such as prior period information) or untested financial information does relate to the period under audit. The auditor's decision in this regard required the application of judgement.

If the auditor opts to quantify materiality using one of the common rules, he should amend his quantification of planning materiality during the testing phase of the audit if he then establishes that the size of the company is significantly different from what he expected during the planning phase. Such a change should be documented, along with the impact thereof on planned testing.

The quantification of final materiality is commonly done using the same common rules, but the auditor (having completed testing) can now use tested financial information for the period under audit for the calculation thereof.