According to the text, auditors have to make judgments concerning materiality on every audit. Since the auditing standards give no formal guidance for how to determine materiality, auditors must rely on their own experience. Determine at least three (3) qualitative factors that affect the auditor’s judgment. Provide a rationale for your response.
According to the text, auditors rely on the audit risk formula to determine the types and amount of audit evidence to collect in order to keep the overall audit risk of engagements to a minimum or below defined tolerable limits. Suggest an alternative to the audit risk equation in order to mitigate audit risk. Support your rationale with examples of the successful use of the alternative strategy.
Materiality can be defined as magnitude of an omission or a misstatement of theaccounting information, it is an important because of the financial statements are materially misstated and users’ decisions may be affected so thereby it cause a financial loss to the users of the financial statement.
The auditor must therefore exercise considerable professional judgement in the application of materialty. A preliminary judgement about materiality is set for the financial statements as a whole, which is the maximum amount by which the auditor believes the financial statements could be misstated and still not affected the decisions of reasonable user.
Several factors affect the preliminary judgement about materiality and are:- Materiality is relative rather than an absolute concept, it is necessary to have bases for establishing whether misstatement are material. For example in the audit of manufacturing company the auditor might use as a bases: not income before taxes total assets, current assets, and working capital. For governmental unit such as school district, there is no net income before taxes and therefore that would be unavailable base. Instead, primary bases would likely be the fund balances, total assets & perhaps total revenue.
Expected distribution of financial statements will affect the preliminary judgement of materiality. If the financial statements are widely distributed to users the preliminary judgement of materiality will probably be set lower than if the financial statement are not expected for widely distributed.
level of acceptable audit risk might also affect the preliminary judgement of the materiality, and lastly qualitative factors affect materiality decision.
The following qualitative factors are likely to be considered in evaluating materiality.
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i) Amounts involving fraud are generallylly considered more important then an uninternational errors of equal to dollar amounts.
ii) Misstatements which are are otherwise minor could be material if there are possible consequences arising from the contractual obligations.
iii) Misstatements which are otherwise immaterial can be if they affect the trend in earnings.
