ISA 320 Audit Materiality is one of the international standards on Auditing. It serves to expect the auditor to establish an acceptable materiality level in designing the audit plan. Materiality is the amount by which the financial statement must change in order to change the decisions made by users of the financial statement
Materiality in the financial statements can be assessed through qualitative
and quantitative factors;
The list of factors that determine materiality is not exhaustive. Some of the
factors that need to be considered when making a judgement on materiality are:
a) Relative significance
This is to determine the materiality of the item by viewing its significance in
relation to the class to which it belongs.
b) Comparison with the corresponding previous year’s figures: patterns of
income and expenses Comparison with previous year’s figures under similar headings is yet another criterion for determining materiality.
c) Transactions of abnormal and non-recurring nature If a transaction is of an abnormal or of non-recurring nature, it is considered to be material, even if the amount involved may not be large e.g. related party transactions, acquisition of new business, research and development expenses etc.
d) Statutory requirement. Omission of any amount that has to be disclosed because of statutory requirements is material in nature. Hence, qualitative materiality refers to a transaction which is not material because of its size, but because of the nature of the item e.g. statutory requirement.
e) Regular checks. Few items should be regularly checked for misstatements even though their monetary value might be insignificant. This is because these items are material to the users. Certain errors such as critical point errors need to be examined as they have the capability to change a loss into a profit.
f) Recurring errors. Certain errors are recurring errors and occur frequently. While determining materiality levels, it is important toinclude these items even though they are of small amounts as they signify a weakness in the accountingsystem. For example, if the internal audit report of the previous year indicates that there were errors in thecalculation of wages during the earlier year because it was handled by a trainee, then the auditor, during thecurrent year, will have to check the calculation of wages for amounts which exceed the set materiality level.
Calculated materiality amounts derived using quantitative approaches may
be increased or decreased based onthe auditors’ professional judgement
about the possible effect of qualitative factors.