If your organization is being audited by an external (independent) auditor, you have probably heard them use phrases like “that’s material” or “that’s not material.” This posting attempts to clarify how auditors make that determination as it relates to your business.
The concept of materiality recognizes that some matters, either individually or in the aggregate, are important for financial statements to be fairly presented in conformity with generally accepted accounting principles. In performing the audit, the auditor is concerned with matters that, either individually or in the aggregate, could be material to the financial statements. The auditor’s responsibility is to plan and perform the audit to obtain reasonable assurance that material misstatements, whether caused by errors or fraud, are detected.
The auditor's consideration of materiality is a matter of professional judgment and is influenced by the auditor’s perception of the needs of users (which could be different from client to client) of financial statements. Materiality has been defined as "the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement." That discussion recognizes that materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative considerations.
The evaluation of whether a misstatement could influence economic decisions of users, and therefore be material, involves consideration of the characteristics of those users. Users are assumed to:
a. Have an appropriate knowledge of business and economic activities and accounting and a willingness to study the information in the financial statements with an appropriate diligence;
b. Understand that financial statements are prepared and audited to levels of materiality;
c. Recognize the uncertainties inherent in the measurement of amounts based on the use of estimates, judgment, and the consideration of future events; and
d. Make appropriate economic decisions on the basis of the information in the financial statements.
The determination of materiality, therefore, takes into account how users with such characteristics could reasonably be expected to be influenced in making economic decisions.
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