Materiality and Its Importance in Auditing - Assignment Example

Table of Contents Introduction 2 Materiality and Its Importance in Auditing 2 Confidentiality of Levels of Materiality Utilised By Auditors 4 Literature Review on the Confidentiality and Importance of Materiality 4 Impact of Recent Audit Reporting Regulations on Audit Practice Of Disclosure of Materiality 6 Analysis of Implementation of Changed Audit Practices 7 Conclusion 7 References 8 Introduction Materiality is a concept in accounting and auditing related to the significance of discrepancy, transaction, and amount. Materiality refers to the omission of quantitative and qualitative information that could influence the decisions of the decision makers (Beasley & Carcello, 2009). The concept of materiality has been discussed in the reporting of financial statement frameworks by using different terms (OSSAI, 2014). After the financial crisis of 2008, accountability in business sectors has achieved considerable importance. Decisions are made on the basis of financial information by business stakeholders. Therefore, it has become crucial that the financial information provided to stakeholders is based on facts and this information is free from all mistakes. The objective of financial information should be to present a fair view of businesses’ financial performance. It has been analysed that to measure the level of materiality that is acceptable at the time of preparing a financial statement, no benchmark has been applied. Materiality has a drastic impact on the financial performance or economic impact of the firm; therefore, auditors measure materiality on the basis of their in-depth understanding of the economic consequences of such decisions, institutions, and professional expertise. Auditors used to keep the levels of materiality in financial statement confidential, and the privacy level is higher. Materiality and Its Importance in Auditing With the increase of internationalisation and globalisation, information has become more crucial for the business world. For the economic life of businesses, information is the dominant factor, and to accessing this information has become essential for the success of the business. Materiality has an extreme importance in preparing and designing a quality audit report. It is considered as a range or scale of level that does not make any impact on the opinion and choice of shareholders or a reasonable person by Financial Accouning Standards Board. This means such changes in information do not make an impact on a person who considers changing the decision or perspective. An audit report is a representation of professional reasoning that can be applied in any domain of activity, and the main objective is to analyse discrepancies to find out some measure to eliminate the discrepancies. The audit aims to provide complete and accurate financial statements that have an impact on economic operations according to the regulations in force. The dependence of materiality depends on the specific circumstances of mistaken presentation. The concept of materiality is applicable to the unintentional and intentional misstatements of accounts. Determining the materiality and its collective and individual impact on the overall financial statements is essential for auditors. The audit reports are not able to identify and present completely fair information. Thus, materiality gives compassionate attention to the omission, and it bears substantial risk (Johnstone, Gramling & Rittenberd, 2013; Maria & Franca, 2002). Several risks are associated with the misstatement or misrepresentation of financial statement. The basic categories of material misstatement risk are inherent risk and control risk. Inherent risk represents the misstatement of material that is produced at the firm level when the financial statements are produced. However, account level and internal control system of organizations do not take control risks into consideration and do not apply any remedies to control or correct such misstatements. Both inherent and control risks are controlled by the clients or the employees in the operations. These risks result in audit and detection risk; auditor is liable to determine and control audit and detection risks (Johnstone, Gramling & Rittenberd, 2013). Confidentiality of Levels of Materiality Utilised By Auditors Materiality in the audit report can influence the quality of the financial statement as well as the level of trust of the audit report. There can be differences between the auditor and the organizations’ management regarding the fair and true value of financial information. Threshold is an important aspect of materiality that makes a significant effect in the auditing process. Threshold level is also described as the acceptable level or the level of materiality that can be included in the financial information (CFRS, 2013; Johnstone, Grambling, & Rittenberg, 2013). It has been identified that if the level of materiality is not defined, then it can have a serious impact on the financial position of the organization. According to Brennan & Gray (2005), the management of the organizations tends to keep several information secret and this may lead to materiality. Different types of possession make impact on the secrecy of financial auditing. According to Guedhami et al (2009), organizations like to select auditors that can keep the materiality secrecy level high at the time of conducting the audit of financial statements of the organization to sustain the political interest of administration. Auditors take full advantage of this aspect and take part effectively to maintain the interest of administration. It is essential for auditor to ensure that financial statements do not include material misstatements or errors that could influence the information presented. Literature Review on the Confidentiality and Importance of Materiality Confidentiality and importance of materiality has great importance in the preparation of standards that ensure the level of quality audit reports. Even auditors give massive consideration to the secrecy of audit reports and consider it as an important factor. Importance of secrecy of materiality in terms of national culture have been examined and it has been concluded that quality auditors are not hired by the countries that pay greater stress on the secrecy of material (Hope et al , 2008). It has been concluded by Turner (2007) that the choice of materiality has an impact on the comparability, consistency, and transparency of financial statements. Due to lack of guidance, subjective heuristic is utilized by auditors to determine misstatements. Therefore, it is essential for the auditing organizations to have profound standards and framework of the audit according to the cultural factors of countries. Huang (2006) examined in his research that if investors have non-rational attitude towards investment then the exploration of materiality should be changed in a way in which standard investors portray the information instead of altering the description materiality from rational investors’ point of view. The five qualitative factors are identified for the integration of quality of audit reports. At the same time, these factors are important for controlling secrecy and dealing with materiality in a particular situation of government affairs auditing. These five factors are the most important factors and can make a contribution in the feasibility and generality of the audit. These factors are known as experience, political significance, focus of the public, internal control inefficiency, and funds’ exclusiveness (Zhou, 2012). Auditors always have to deal with different challenges because of disparities between the claims of the auditors and the organizations. These sources of challenges put down in the fact that materiality is judgmental. However, the ideal materiality is the one that is not absolute with ambiguity or uncertainty. These factors can be tested and applied in the particular framework of the country for the evaluation of materiality. This can produce the specific model of materiality evaluation in the reporting of financial information; even a country specific model of materiality measurement can be produced with the help of these factors (Jennings, Reckers, & Kneer, 1991). However, if the widespread view is considered, that most of the secrecy tool of materiality and materiality is in the hand of auditors, then it leads to raise a question on the feasibility and capability of information provided by the auditors in the shape of financial information. It has been analyzed that there is no hard and fast rule that has been defined about materiality. Therefore, making decision on the basis of information that has been provided by the auditors in terms of financial statement is not a vice step (Scharfman, 2012). However, in contrast; it has been stated by the Kearns (2007) that to reduce the negative impact of materiality secrecy in the procedure of quality audit, mentioning the level of materiality preserved by the auditor during the assessment of transactions is more practical. This can be done without any difficulty as it has been determined that auditors are allowed to prepare the unrestricted notes on any transaction in the report of auditors. Impact of Recent Audit Reporting Regulations on Audit Practice Of Disclosure of Materiality The regulation of ISA 320 has taken effect since the end of 2009. A comprehensive plan to implement the materiality and for the sake of the respective disclosure of materiality was produced by international standard of auditing (ISA). To consider materiality in the performance and planning in the auditing process of organizations, a standard that is known as Auditing Standard No 11 has been set by PCAOB. In this regulation, some standards have been set for auditors that are required to be followed when auditors conduct financial statements’ audit of any organization. In the guideline, it has been asked from the auditors to set an acceptable level of materiality for the individual accounts and financial entries. Moreover, auditor is responsible for preparing a tolerable level of materiality; they are required to consider the application of standards of materiality at diverse places in the report of the audit (PCAOB, 2013). Analysis of Implementation of Changed Audit Practices Due to increased uncertainties, some set of rules has been proposed by the European parliament to improve the audit quality of government organizations. The major example of proposed regulations is commanding the rotation of the firms doing audit and providing services to the entities of public interest. Some recommendations have been proposed to enhance the transparency and accountability in the auditing of financial statements (European commission statement, 2014). In the review of FRC, it has been addressed that all of the organization are facing similar issues and are not able to find the high standards of quality. It has been identified that auditors are liable to report the material misstatements first to management and then if they are permitted they can report this misstatement to the committee of auditors. However, if auditor and management decide to maintain the secrecy of material information then these changed regulations will not make any difference; even a consensus among auditors can blur the guidelines of audit (Willenborg, 2004; Brown, 2012). Conclusion Multiple changes in regulations have been made in the last few years. However, now it has become essential to develop some standards to develop a culture in which materiality disclosure is implied on every financial transaction. In order to defend the stakeholders and investors, huge importance is given to auditing practices. Though, there is a need to improve the quality level of audit, and there must be a right balance between the quantitative and qualitative measures for the assessment of the secrecy and reporting of materiality. References Beasley, S. M., & Carcello, V. J. (2009). GAAS Guide 2009: A Comprehensive Restatement of Standards for Auditing ... United states of America: CCH. Brennan, N., & Gray, S. J. (2005). The Impact Of Materiality: Accounting’s Best Kept Secret. Asian Academy Of Management Journal Of Accounting And Finance. Vol. 1. pp. 1-31. European Commission Statement. (2014). European Parliament Backs Commission Proposals On New Rules To Improve The Quality Of Statutory Audit. European Commission. Available from: < http://europa.eu/rapid/press-release_STATEMENT-14-104_en.htm?locale=en > [Accessed 10 December 2014]. FRC. (2013). Audit Quality Thematic Review: Materiality. Available from: < https://www.frc.org.uk/Our-Work/Publications/Audit-Quality-Review/Audit-Quality-Thematic-Review-Materiality.pdf > [Accessed 10 December 2014]. Guedhami, O., Pittman, J. A., & Saffar, W. (2009). Auditor choice in privatized firms: Empirical evidence on the role of state and foreign owners. Journal Of Accounting And Economics, Vol.48, no.2, pp.151-171. Huang, P. H. (2005). Moody investing and the Supreme Court: Rethinking the materiality of information and the reasonableness of investors, Supreme Court Economic Review. Vol.13, no.1,pp 99–131. Hope, O. K., Kang, T., Thomas, W., & Yoo, Y. K. (2008). Culture and auditor choice: A test of the secrecy hypothesis. Journal Of Accounting And Public Policy, Vol. 27, no. 5, pp.357-373. International Standard On Auditing 320. Materiality In Planning And Performing an Audit. (n.d.). Available from: < http://www.ifac.org/sites/default/files/downloads/a018-2010-iaasb-handbook-isa-320.pdf > [Accessed 10 December 2014]. Johnstone, K., Gramling, A., & Rittenberg, L. (2013). Auditing: A Risk-based Approach to Conducting a Quality Audit. Cengage Learning. Jennings, M. M., Reckers, P. M., & Kneer, D. C. (1991). The auditors dilemma: The incongruous judicial notions of the auditing profession and actual auditor practice. American Business Law Journal, vol. 29. no.1, pp.99-126. Kearns, F. E. (2007). Materiality & the audit report: Its time for disclosure. Available from: < https://ritdml.rit.edu/bitstream/handle/1850/8790/FKearnsArticle2007.pdf?sequence=1 > [Accessed 10 December 2014]. Maria, M., & Franca, D. ( 2002). THE IMPORTANCE OF MATERIALITY IN AUDIT. http://fse.tibiscus.ro/anale/lucrari2012/kssue2012_039.pdf PCAOB. (2013). Auditing Standard No. 11: Consideration of Materiality in Planning and Performing an Audit. Available from: < http://pcaobus.org/Standards/Auditing/pages/auditing_standard_11.aspx > [Accessed 10 December 2014]. Scharfman, J. A. (2012). Private Equity Operational Due Diligence: Tools to Evaluate Liquidity, Valuation, and Documentation (Vol. 770). John Wiley & Sons. Turner, L. J. (2007). Aligning Auditor Materiality Choice and the Needs of a Reasonable Person. Journal of Forensic Accounting VIII (2): 29-52. Zhou, Y. (2012). Government audit materiality (part two): conceptual and practical implications of a qualitative materiality framework: seven case studies and a comparative conceptual work. International Journal of Economics and Finance, Vol.4, No. 2, pp. p85. Read More