Financial statements are often complex. This is where materiality plays an important role in determining the aspects that should be the focus of the audit.
Materiality also helps auditor. identify errors that have a big impact if a misrepresentation occurs.
In this article, we will discuss more about what is materiality in auditing and how it is applied. Come on, check it out!
What is materiality?
Materiality is a measure used to determine that there are no material misstatements in the audit process that can significantly affect the decisions of users of financial statements.
If an item is missing or misreported, and its correction may alter the interpretation of the financial statements, the item is considered material.
The Auditor will determine whether an item is professionally material based on the auditor's view of the client's financial information needs.
The Principle Of Materiality
The application of this concept has several principles that must be met, namely:
- Errors in financial statements are classified as material if the decisions of users of financial statements are affected by them.
- Materiality is assessed on the basis of a combination of the size and nature of the fallacy as well as the external situation to determine the degree of its significance.
- Materiality is assessed taking into account the general needs of users of financial statements.
Importance of materiality in auditing
In the audit, the concept of materiality plays an important role because:
1. Is The Basis For Determining The Audit Opinion
International Standards on Auditing require auditors to ensure that financial statements are free from material errors as a basis for providing opinion.
If the wrong item is immaterial, the auditor will give an unqualified opinion.
Conversely, if the error is found to be material and widespread, the auditor may provide unnatural opinion.
2. Assist in Risk Assessment in audits
This concept is able to analyze how far inaccuracies and errors in financial statements occur.
If the auditor judges that the error is below the materiality threshold, then the risk of the error is considered acceptable.
Conversely, if the error exceeds the materiality threshold, the auditor should evaluate its impact further.
3. Creating relevant financial statements
The concept of materiality plays an important role in ensuring that report compiled financials are accurate, reliable, and relevant to the stakeholders who rely on such information.
By applying materiality, the auditor can ensure that the information presented in the financial statements has a significant impact.
Types of materiality
1. Overall Materiality
Overall materiality is the limit of the maximum value of errors or misstatements in financial statements that can still be accepted without affecting the decisions of users of financial statements.
This limit is established taking into account who are the main users of the report as well as quantitative and qualitative factors.
2. Overall Performance Materiality
Overall performance materiality it has fewer threshold values than overall materiality.
This type of threshold is used to provide a space or buffer to anticipate small errors that may not be detected during an audit.
The goal is to ensure that even if a small error is not found, its total number will still not exceed the limit overall materiality.
3. Specific Materiality
Specific materiality is a materiality limit applied to certain transactions, accounts, or information that is considered particularly important or sensitive.
Examples are transactions with related parties, disclosures of management salaries, or significant accounting estimates.
This limit is often lower than overall materiality because the focus is on specific elements that can have a major impact on users of financial statements if misrepresentations occur.
The Definition Of A Material Object
1. Nominal Size
This method uses the nominal size or absolute value of an item as the basis for determining materiality.
This threshold depends on company policy, the nature of the business, and the needs of users of financial statements.
For example, if a company sets a threshold of Rp100 million, then a listing error of Rp150 million would be considered material.
2. Percentage of gross profit or assets
This method determines materiality by comparing the value of items against important elements in financial statements, such as gross profit or total assets.
For example, a company sets a threshold of 3% of gross profit. If gross profit is Rp10 billion, then an error of Rp400 million will be considered material because it exceeds 3%.
3. Influence on Decision Making
In this method, the main focus is on the impact of information on the decisions of the users of financial statements.
An item is considered material if its presence or absence affects the decision made stakeholders.
For example, if a company fails to record significant debt, that information could influence investors ' decisions regarding the company's stock so materially.
4. Risk Factors
Information relating to business areas or transactions that have a high level of risk is likely to be considered material.
Failure to disclose such information can have a major impact on the company.
For example, if a pharmaceutical company faces legal risks related to drug patents, then all financial information related to those risks would be considered material.
5. Qualitative Considerations
Information that has an impact on reputation, ethics, or legal compliance is considered material even if it is of little value because it affects the perception of relevant stakeholders.
For example, a small legal case with a loss value of only Rp50 million can be considered material if it concerns an accusation of fraud by a company executive.
Materiality Level
Based on these determining factors, the auditor will conduct an audit based on 2 levels of consideration, namely:
- Level Of Financial Statements: The smallest number of errors that can make financial statements inconsistent with applicable accounting principles. That is, if there are misstatements exceeding this level, decisions made on the basis of such financial statements may be incorrect.
- Balance Rate: The smallest amount of error in the balance of a particular account that is considered significant. The materiality of the balance rate considers the material in the account balance regardless of the amount of the balance itself.
Examples of materiality in the Audit
An error in the transaction of Rp15, 000, the impact will be small and does not affect the decision. Conversely, if the nominal is large such as IDR 15,000,000, it can have a big impact and be material.
However, the nominal magnitude is not the only factor. If an error of Rp15, 000, 000 occurs in a company with annual revenue of Rp100 billion, the impact is small (only 0.015%). But if it happens to a company with revenue of Rp100 million, the impact is large (15%).
In addition, errors involving fraudulent acts even if they are of little value because they involve legal and reputational risks for the company.
This software Audit as a materiality solution
This software audits, such as Audithink's Comprehensive Features, able to assist in dealing with materiality efficiently and accurately.
This software audits make it easy to analyze large amounts of data to find significant or high-risk transactions.
With the best features, an audit software can identify errors or suspicious transaction patterns.
Conclusion
It can be concluded that the concept of materiality is a threshold related to how much impact a Financial Statement Information has on the decision-making of the parties concerned.
By understanding this principle, auditors can ensure that the financial statements presented are relevant, reliable, and reflect information that is truly significant to stakeholders.
