Materiality

Q Determination of materiality level requires professional judgment on the part of the auditor.

(a) Briefly describe the importance of materiality in the following stages of audit:

(i) Planning stage

(ii) Reporting stage

(b) What aspects of materiality should be documented by an auditor in the working papers?

(i) Planning stage – The concept of materiality is used in determining the nature, timing and extent of further audit procedures;

(ii) Reporting stage – The materiality concept is used in evaluating the effect of uncorrected misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report.

(b) The auditor shall document the following aspects of materiality:

(i) Materiality for the financial statements as a whole;

(ii) Performance materiality;

(iii) Basis of computing materiality; an

(iv) Any revision of (i) to (ii) as the audit progresses . Materiality and performance materiality is discussed on Auditorforum.com.

Mr. A is the audit senior on the audit of Hadid Limited (HL). Upon his manager’s instruction Mr. A had determined the acceptable materiality level to be Rs. 10 million at the initial planning stage. However, at the time of evaluating the results of audit procedures carried out at the interim stage, he has reduced the materiality level to Rs. 7.5 million.

Required:

(i) Identify the possible causes which motivated Mr. A to reduce the materiality level.

(ii) Discuss the impact of reduction in the materiality level on audit risk and the audit procedures to be performed.

(i). Mr. A may have decided to change the level of materiality because of any of the following causes:

a change in circumstances; or
a change in the auditor’s knowledge as a result of performing audit procedures.

(ii). There is an inverse relationship between materiality and the level of audit risk. This relationship is considered by an auditor in determining the nature, timing and extent of audit procedures.Mr. A reduced the materiality level which resulted in increase in audit risk. Therefore, in order to compensate the effect of increased audit risk, he should either:

reduce the assessed risk of material misstatement, where this is possible by carrying out extended or additional tests of control; or
Reduce the detection risk by modifying the nature, timing and extent of planned substantive procedures.

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