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Audit & Assurance

  1. 1. A practical guide to external audit work Ahmad Tariq Bhatti FCMA, FPA, MA (Economics), BSc Dubai, United Arab Emirates
  2. 2. ContentsContents.................................................................................................................................2Definitions of Auditing...........................................................................................................4The auditing framework.........................................................................................................6Stages of External Audit Work................................................................................................8Audit Evidence......................................................................................................................15Audit Risk & Materiality.......................................................................................................26 (2/26)
  3. 3. Chapter OneDefinitions of Auditing (3/26)
  4. 4. Chapter 1 Definitions of Auditing1. Montgomery Auditing is a systematic examination of books and records of a business or other organization in order to ascertain or verify and to report upon the facts regarding its financial operations and the results thereof.2. W.W. Biggs An audit may be said to be such an examination of books, accounts, vouchers of a business, as will enable the auditor to report, whether he is satisfied that the balance sheet is properly drawn-up as to give a true and fair view of the state of affairs of the business and that of the profit or loss for the financial period, according to the best of the information and explanations given to him and as shown by the books, if not, to report in what respect he is not satisfied.3. Taylor & Perry An audit is an investigation by an auditor into the evidence from which the final revenue accounts and balance sheet or other statements of an organization have been prepared, in order to ascertain that they present a true and fair view of the summarized transactions for the period under review and of the financial state of the organization at the end date. So, enabling the auditors to report thereon.4. L.R. Dicksee Auditing is an examination of accounting records with a view to establishing whether they correctly and completely reflect the transactions to which they report on.5. F.M.R. de’ Paula Audit denotes something much wider, namely the examination of balance sheet and profit and loss account prepared by others. As a result of this examination of the books of accounts, vouchers etc. and of his enquiries, the auditor must satisfy himself that balance sheet and profit and loss account are drawn up properly, so as to exhibit a true and fair view of the state of affairs and the earnings of a particular concern.6. R.R. Coomber Modern audit is the verification of financial statements usually a balance sheet and profit and loss account, in the light of certain accounting principles to establish whether or not it is the true statement and correctly drawn up.7. J.R. Batliboi Audit is an intelligent and critical scrutiny of books of accounts of a business with the documents and vouchers from which they have been written up, for the purpose of ascertaining whether the working results of a particular period as shown by the profit and (4/26)
  5. 5. loss account and also financial position as reflected in the balance sheet, are truly and fairly determined and presented by those responsible for their compilation.8. R.E. Schlosser Auditing is a systematic examination of financial statements, records, and related operations to determine adherence to generally accepted accounting principles, management policies, or stated requirements.9. Australian Auditing Standard 104 (AUS 104) A service where auditor’s objective is to provide a high level of assurance through: (a) the issue of a positive expression of an opinion that enhances the credibility of a written assertion(s) about an accountability matter (attest audit); or (b) the provision of relevant and reliable information and a positive expression about an accountability matter where the party responsible for the matter does not make a written assertion(s) (‘direct reporting audit’).10. A.W. Holms & W.S. Overmger Traditionally, auditing is an objective examination of financial statements prepared by management plus the examination and evaluation of information gathering functions and all phases of management and activities, in order to ascertain if operations are conducted in an effective and efficient manner.11. Combine Council of Accountancy Bodies An audit is the independent examination of and expression of opinion on, the financial statements of an enterprise by an appointed auditor in pursuance of that appointment and in compliance with any relevant statutory obligation.12. American Accounting Association (AAA) in A Statement of Basic Auditing Concepts, defined as: A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users. Detail of key terms used in this definition is given below: (a) Systematic process: Audits are structured activities that follow a logical sequence. (b) Objectivity: This is a quality of the methods by which information is obtained and also a quality of the person doing the audit. Essentially it means freedom from bias. (c) Obtaining and evaluating evidence: This is a matter of examining the underlying support for assertions or representations. (5/26)
  6. 6. (d) Assertions about economic actions and events: This is a broad description of the subject matter that is audited. An assertion is essentially a proposition that can be proved or disproved. (e) Degree of correspondence… established criteria: This means an audit establishes the conformity of assertions with specified criteria. (f) Communicating results: To be useful, the results of the audit need to be communicated to interested parties by either oral or written means.13. Spicer & Pegler An audit is the independent examination of, and expression of opinion on, the financial statements of an enterprise by an appointed auditor in pursuance of that appointment and in compliance with any relevant statutory obligation.14. International Standard on Auditing 1 An audit is the independent examination of financial statements or related information of an entity, whether profit oriented or not and irrespective of its size, or legal form, when such an examination is conducted with a view to expressing an opinion thereon. The auditing framework The auditing framework is composed of the following:  Applied knowledge of International Standards on Auditing (ISAs)  Command on applicable laws and regulations for the specific set of financial statements (e.g., CO, 1984, Banking Companies Ordinance, 1962, Insurance Companies Acts, etc., etc.)  Proficiency in applying auditing procedures and techniques  Expert knowledge of applicable financial reporting framework to the specific set of financial statements like IASs, IFRSs etc., etc.  Skills in computerized environment like ERP packages  Skills in MS Office (Excel, Word etc., etc.)  Knowledge of the Industry in which company falls  Knowledge of the business of the company  Knowledge of the client management and their working style  Audit team that has a good mix of skills in above mentioned areas (6/26)
  7. 7. Chapter Two Stages of External Audit WorkA practical Guide to planning, performing & controlling work (7/26)
  8. 8. Chapter 2 Stages of External Audit Work1. Audit Acceptance • Audit accepting and agreeing on terms of reference/engagement is the responsibility of an engagement partner. • All legal, ethical, and professional considerations are dealt for acceptance and continuance of audit assignments in accordance with Code of Ethics for Chartered Accountants as enacted in CA Ordinance, 1961 (any other applicable) and ISA 220. • Preparing, issuing, and revising engagement letter according to the requirements of ISA 210. The scope and performance of work is covered in the letter along with all important matters relating to the engagement.2. Audit Planning & Control • An auditor should plan an audit in a manner that helps him to finish the engagement in an efficient and effective manner. A planning file is prepared before an audit starts which is reviewed by the top management of an accounting firm. It reflects all aspects of an audit engagement both financial and non-financial (ISA 300). • The auditor should develop an overall strategy for the audit engagement (ISA 300). • Establishing objectives, scope, extent and critical aspects of an audit job. • The auditor should develop a planning in order to reduce audit risk to an acceptably low level. (ISA 300). • The identification of sources of audit evidence and its relationship to critical audit objectives (Audit planning matrix) (ISA 500-501). • Establishing materiality levels/standards, sample size, and sampling techniques (ISA 320 & 530). • Establishing materiality and evaluating whether the judgment about materiality remains appropriate as the audit progresses. • The auditor should make inquiries of those charged with governance to determine whether they have knowledge of any actual, suspected or alleged fraud affecting the company under audit. (ISA 240) • Documenting the nature, timing and extent of planned risk assessment procedures sufficient to assess the risks of material misstatements. (ISA 315) • An auditor should perform following risk assessment procedures to obtain an understanding of a company and its environment, including its internal control: o Inquiries of management o Analytical procedures o Observation & Inspection (ISA 315) • Analyzing the consistency of financial and related information by substantive analysis. • Designing, documenting, and re-evaluation of an audit plan. (8/26)
  9. 9. • Evaluating and documenting management information system details.3. Performance and Execution of Audit Work • At this stage audit team performs various audit procedures and techniques for obtaining audit evidence of such quantity that minimizes audit risks to acceptable levels. • An auditor should document a company’s selection and application of accounting policies and review them for their appropriateness with the business-line and ensure consistency with the applicable financial reporting framework of the industry. (ISA 315). • Evaluating and documenting design of accounting and internal control system and determining the extent of reliance to be placed on it. (ISA 315) • Designing interim audit program on an initial assessment of internal controls system. • An auditor should obtain understanding of how a company has responded to risks arising from IT (ISA 315). • Identifying and documenting the internal controls working in the system. • Performing compliance tests on internal controls. • Ascertaining the results of compliance tests and documenting the risk in each area separately. • Recommending additional controls to mitigate the risks identified with the existing controls. • Writing the final audit programme in the light of interim audit findings and audit objectives set at the planning stage. • Applying the substantive analysis and tests in accordance with the final audit programme. • Determining adequacy of substantive tests after the initial results start coming. • Devising additional audit tests for risks identified at the later stages. • Review the audit work to ensure sufficiency and appropriateness of audit evidence and overall work quality. • At planning and performing stages of work, an auditor is required to ensure the appropriateness of the going concern assumptions in the preparation of financial statements (ISA 570). • The auditor should obtain audit evidence that management acknowledges the responsibility for the fair presentation of financial statements in accordance with applicable financial reporting framework, and has approved the financial statements (ISA 580). • If management refuses to provide a representation that the auditor considers necessary the auditor should express a qualified opinion or disclaimer of opinion (ISA 580). • The auditor should perform audit procedures designed to obtain sufficient and appropriate audit evidence regarding the identification and disclosure by management of related parties and the effect of related party transactions that are material to the financial statements (ISA 550). (9/26)
  10. 10. • An audit process must be efficient and effective in fulfilling the objectives of an audit engagement. An auditor must minimize the risk of not finding material misstatements in account balances and at the same time complete the audit work on agreed time period. • The auditor should obtain sufficient appropriate audit evidence about compliance with those laws and regulations generally recognized by the auditor to have an effect on the determination of material amounts and disclosures in the financial statements. Further, the auditor is required to have sufficient understanding of these laws and regulations in order to consider them when auditing the assertions related to determination of the amounts to be recorded and disclosures to be made (ISA 250).4. Specific Documentation Requirements # ISA Title Para 1 210 Terms of an audit engagement 5 2 220 Quality Control for audits of historical financial 11-14, 16, 25, 27, information 30, 31, 33 3 240 The auditor’s responsibility to consider fraud in an audit of 60, 107-111 financial statements 4 250 Consideration of laws & regulations 28 5 260 Communication of audit matters with those charged with 16 governance 6 300 Planning an audit of financial statements 22-26 7 315 Understanding the entity and its environment and assessing 122-123 the risk of material misstatement 8 330 The auditor’s procedures in response to assessed risks 73, 73(a), 73(b) 9 505 External confirmations 33 10 580 Management representations 10 11 600 Using the work of another auditor 14 (10/26)
  11. 11. 5. Audit Reporting and Forming of Audit Opinion • Reporting results of audit procedures is the final stage of an audit work. • Manager and engagement partners finalize the process of audit reporting. • Summarizing the results of audit procedures i.e. accounting adjustments, management letter etc. etc. • Reviewing the sufficiency and appropriateness of audit evidence gathered during the audit process. • Reviewing subsequent events, going concern status, management representations, and truth and fairness of financial statements. • Identifying and recommending appropriate action on weaknesses and findings surfaced during the audit process. • Discussions with client management on all issues highlighted during the audit work and documenting their feedback. • The auditor should inform those charged with governance of those uncorrected misstatements noted by the auditor during the course of audit that were considered by management as immaterial to the financial statements taken as whole. • Summarizing audit results that highlight the audit procedures applied, audit observations and management comments on each observation. • Forming an audit opinion after audit issues are cleared by client management (ISA 700). • Communicating the final draft to client management. • Preparing a final audit report with or without modified opinions. • Attending AGM for responding to any audit related queries of members. • Determining the potential effects of audit report modification due to subsequent events (if any), (ISA 560). • Documenting audit points for next years’ audit. • Documenting the follow up results of the audit.6. Subject-wise Grouping of ISAs Number # Group Subject covered of ISAs 1 100-199 Introductory matters - Objectives & General Principles Governing an 2 200-299 8 Audit of Financial Statements 3 300-499 Risk Assessment & Response to Assessed Risk 6 4 500-599 Audit Evidence 11 5 600-699 Using Work of Others 3 6 700-799 Audit Conclusion & Reporting 5 7 800-899 Specialized Areas 4 Total 37 (11/26)
  12. 12. (12/26)
  13. 13. Discuss with Director Finance or relevant Head about the scope, timing and extent of audit work.Planning Ensure Engagement Letter is sent to the client. Entry meeting with client management to discuss the conduct of auditPerforming Ensure audit testing performed, involving documenting the systems under review, examining key documents and interviewing staff. Draft audit results after discussion with client management in exit meeting Frame audit opinion based on issues after the discussion with clientReporting Issue draft Audit Report to client for further discussions. Issue final Audit Report Follow up by audit assurance staff on progress with implementation of audit recommendations Audit Process Defined (13/26)
  14. 14. Chapter Three Audit Evidence Description, Collection & Evaluation ProceduresFor Selected Areas from Statement of Financial Position [As required by International Standards on Auditing] (14/26)
  15. 15. Chapter Three Audit EvidenceISA 500 entitled as Audit Evidence (AE) provides definition, collection andevaluation procedures for AE gathered during audit field work. • AE is the information used by an auditor in arriving at the conclusions on which the audit opinion is based. • The information that constitutes AE includes accounting records underlying the financial statements. Examples are as given below: o Journals, ledgers, subsidiary ledgers, o Budgets, estimates, projections, o minutes, internal and external confirmations, o Actuarial reports, bank reports, control manuals, accounting manuals, operating procedures’ manual o Cost allocations, reconciliations, computations, o Supporting documents like invoices, cheques, bills, o Records of electronic fund transfers, o Any information requested during the course of an audit from the client o Other sources of AE are last year audit files and client working papers. • AE is obtained through the following audit procedures: o Observation o Inquiry o Inspection of tangible assets (also of records and documents) o Re-computation/Recalculation o Vouching o Confirmation o Analytical Procedures • AE is cumulative in nature. • AE should be sufficient and appropriate in order to satisfy an assertion relating to financial reporting. (15/26)
  16. 16. • Sufficiency is the measure of the quantity of AE whereas appropriateness is the measure of the quality of AE.• Sufficiency and appropriateness of an AE are interrelated. o Quantity of AE is based of risk assessment. o Quality of AE is based on reliability of AE.• The reliability of an AE depends on nature and source the following factors: o AE obtained from external sources is more reliable. o AE obtained internally is more reliable when related controls are effective. o AE obtained directly by an auditor is more reliable than the one obtained indirectly or by inference. o Documented AE is more reliable than oral statements of the management. o AE obtained from original documents is more reliable than the one obtained through faxes and copies.• An auditor is required to establish the accuracy and completeness of all information provided to him by the client during the course of an audit.• An auditor should use assertions in sufficient detail to form a basis for the assessment of risks of material misstatements.• Assertions about classes of transactions are: o Occurrence o Completeness o Accuracy o Cut-off o Classification• Assertions about account balances at the year-end: o Existence o Rights & Obligations o Completeness o Valuation & allocation (16/26)
  17. 17. • Assertions about presentation and disclosure: o Occurrence o Completeness o Classification & understandability o Accuracy & valuation Important note The audit of financial statements revolves around above mentioned assertions. If audit work is carried out in accordance with the above mentioned assertions, it shall obtain all its objectives. We have given examples of a few areas from Statement of Financial Position for which audit programs were designed in the light of above mentioned assertions. (17/26)
  18. 18. 1. Accounts Payables Assertion Audit objective Audit procedure Accounts payables are valid obligations • External confirmation Existence to suppliers at the reporting date. • Vouching • Out-of-period liability search Accounts payables include all obligationsCompleteness owed to suppliers at the reporting date. also known as Omitted liability test. • Select transactions from Transactions giving rise to accounts accounts payable ledger and Occurrence payables occurred during the period agree to supporting under audit. documentation. Rights & Accounts payables are obligations owed • Confirmation from documents. Obligations by the company. • Cut-off test Accounts payables are recorded in the • CastingMeasurement correct amount and period. • Agree Dirham value of accounts payable to supporting documents Accounts payables are presented at the • Re-computation Valuation appropriate amount. • Analytical procedures Accounts payables are properly • InquiryPresentation described and classified in Statement of • Scanning ledgers for proper& Disclosure Financial Position and their disclosures classification and description. are correct. (18/26)
  19. 19. 2. Cash & Bank Balances Assertion Audit objective Audit procedure • Bank confirmation Reported cash balance existed at the • Tests of bank reconciliations Existence reporting date. • Physical verification of cash on hand. Check supporting documentation. Recorded receipts and payments related For cash receipts, check remittance Occurrence to the audit period as they occurred. advice, for payments, check documents supporting payments. Tests of bank reconciliation. This is Cash account shows all transactions onCompleteness close of the year. should be done by the client on daily basis. • Bank confirmation Rights & Cash is owned by the company and not restricted or committed. • Cash verification with the Obligations cashier • Check supporting documents to verify Dirham amount of transactions Cash receipts and payments are recorded • Check last cash receipts andMeasurement in the correct amount and in the correct payments recorded before and period. after the balancing date • Test clerical accuracy of bank reconciliation Cash in the Statement of financial Valuation position is stated at the correct amount. Tests of bank reconciliations Cash balances are properly described andPresentation classified in Statement of financial • Scanning of cash receipts and cash& Disclosure position and related disclosures are payment journals correct. (19/26)
  20. 20. 3. Inventory of raw materials, stores & tools Assertion Audit objective Audit procedure • Inspection of physical inventory Inventories included in Statement of Existence financial position physically exist. • Analytical procedures • Confirm stock held at other locations • Selective vouching from sale journals Transactions of purchases and cash paymentsOccurrence recorded when occurred during the period. • Selective vouching from cash book Inventory quantities include all items on hand • Inspection of physical inventory or in transit. Inventory listings are accuratelyCompleteness compiled and properly included in the • Analytical procedures inventory accounts. • Inquire about stock held at other locations The company has legal title or ownership Rights & rights to inventory items, and inventories • Check legal ownership of goods beingObligations exclude items billed to customers or owned by shipped and goods on consignment others • Check Dirham value of purchases to inventory price list. • Agree Dirham value of cash payments to Inventory transactions are recorded in the supporting documents.Measurement correct amount and period. • Check last documents effecting sales and recoveries. • Check clerical accuracy of inventory listing. Inventories are properly stated with respect to • Tests of pricing and summarization the following: • Analytical procedures 1. cost determined by an acceptable • Observation of physical inventory Valuation method consistently applied • Inquiry and scanning 2. slow moving, excess, defective, and obsolete items identified • Check subsequent sales prices and 3. reduced to NRV if lower than cost compare with cost Inventories are properly described andPresentation classified in the Statement of financial • Inquiry and scanning& Disclosure • General procedures position and related disclosures are correct. (20/26)
  21. 21. 4. Investments Assertion Audit objective Audit procedure Investments in securities i.e. shares, bonds, and notes etc., physically exist and • Physical examination Existence loans and advances exist on the reporting • Confirmation date. All investments are included in the • Reconciliation of confirmed andCompleteness Statement of financial position. recorded balance at the reporting date. The entity owns or has ownership rights to • Vouching Rights & all investments included in Statement of • Physical examination Obligations financial position. • Confirmation Investments are recorded in the correct amount. Cut-off is not usually a major issue because there is not a continuous flow of transactions relating to this • Test clerical accuracy of listing ofMeasurement account. Tests as whether the recording investments with original investment takes place in the correct period are certificates. usually included under existence and completeness. • Recomputation, vouching, and tracing Investments are valued properly with Valuation respect to the accounting standards. • Inspection of market quotations or financial statements. Investments are properly described and • General proceduresPresentation classified in Statement of financial • Inquiry& Disclosure position and related disclosures are correct. • Scanning (21/26)
  22. 22. 5. Non-Current LiabilitiesAssertions Audit objective Audit procedure • Confirmation of identified Debt and similar obligations exist at Existence the reporting date. liabilities • General procedures The Statement of financial position • Omitted liability test includes all debt and similarCompleteness • General procedures obligations incurred at the reporting date. • Analytical procedures Debt and similar obligations are legal Rights & • General procedures or specific and definite obligations ofObligations the company. • Inquiry Non-current liabilities are recorded in the correct amount. Cut-off is not usually a major issue because there is not a continuous flow of transactions • Test clerical accuracy of listing ofMeasurement relating to this account. Tests as to non-current liabilities whether the recording takes place in the correct period are usually included under existence and completeness. • Re-computations Debt and similar obligations are Valuation • Vouching presented at the proper amounts. • Tracing Debt and similar obligations arePresentation • General procedures properly described and classified and& Disclosure related disclosures are correct. • Inquiry (22/26)
  23. 23. 6. Property, Plant & Equipment (PPE) Assertion Audit objective Audit procedure • Vouch the purchases100%. • Physical verify additions 100%. PPE included in Statement of financial position physically exists on • Random physical verification of assets Existence the reporting date. Written down other than additions. balances are removed from the books. • Approval of BoD for removing assets from books. • Vouch sold-out assets 100%. • Inquiry PPE includes all capitalisable costs i.e. • Scan for, all additions/deletions are capitalization costs are not expensed recorded at the reporting dateCompleteness out. All additions/deletions are booked • Scanning repairs and maintenance items at the reporting date. that were expensed out rather than capitalized The company has legal title or • General procedures equivalent ownership rights to PPE • Check land registration documents in the Rights & included in Statement of financial name of client. obligations position and the related lease • In the case of leased asset check lease obligation of capitalized leased assets agreement. is recognized. • Scanning of original documents. PPE is recorded at its appropriate carry value. • Test clerical accuracy of PPE listing Cut-off is not an issue because there is not a • Agree line item wise total with continuous flow of transactions relating to thisMeasurement account. The tests as to whether the recording respective subsidiary ledgers. takes places in the correct period are usually • Agree line item wise totals with fixed under existence or completeness. assets register. PPE are appropriately valued and • Re-computations allowances for depreciation or • Apply analytical procedures to verify depletion are computed on the basis of depreciation charge for the year Valuation acceptable and consistent methods. • Vouching costs to invoices Additions only include captalisable • Inquiries about revaluation cost of assets purchased, constructed, • Inquiries about impairment losses or leased. of PPE. PPE is properly described and • General proceduresPresentation & classified in Statement of financial • Inquiry Disclosure position and related disclosures are correct. • Scanning (23/26)
  24. 24. 7. Accounts Receivables Assertion Audit objective Audit procedure Accounts receivable are authentic • External confirmation Existence obligations owed by customers at the • Test from debtors subsidiary ledgers to reporting date. supporting documentation of sale Sales recorded when occurred in duringOccurrence the financial year. • Vouching • Analytical procedures Accounts receivable include all amountsCompleteness owed by customers at the reporting date. • Vouching (change source of samples i.e. to and from ledger and journals) Accounts receivable are owed to the • General procedures Rights & entity and not pledged or subjected to • Inquiry and scanningObligations other outside claims. • Confirmation • Cut-off tests Sales and accounts receivable are • Verify prices, quantity andMeasurement included in the correct period. computation on sales invoices, prices verified to master price list, quantity verified to shipping documentation • Review of aged balances i.e. ageing Accounts receivable are presented at a analysis Valuation reliable estimate of the net realizable • Analytical procedures amount. • Subsequent receipts review Accounts receivable are properlyPresentation described and classified in Statement of • Review the draft financial reports& Disclosure financial position and related disclosures are correct. (24/26)
  25. 25. Chapter Four Audit Risk & Materiality[As required by International Standards on Auditing] (25/26)
  26. 26. Chapter Four Audit Risk & MaterialityMateriality relates to the precision required in the audit of financial statements of a company. Risk relates to the confidence that the audited financial statements are free from material misstatements. Audit risk is the risk that the auditor may unknowingly fail to qualify his opinion on financial statements that are materially misstated.Audit risk is the result of the auditors findings, conclusions, recommendations, or assurance that may be improper or incomplete, as a result of factors such asevidence that is not sufficient and/or appropriate, an inadequate audit process, or misleading information due to misrepresentation or fraud. Factors such as the time frame, complexity, or sensitivity of the work; size of the program in terms of monetary amounts; adequacy of the audited companys systems and processes to detect in-consistencies, significant errors, or fraud; and auditors access to records, also impact audit risk. Audit risk includes the risk that auditors’ procedures will not detect a mistake, inconsistency, significant error, or fraud in the evidence supporting the audit. The assessment of audit risk involves both qualitative and quantitativeconsiderations. The risk related with audit can be reduced but cannot be eliminated completely because of selective work.Audit risk can be reduced by taking actions such as increasing the scope of work; adding experts, additional reviewers, and other resources to the audit team;changing the methodology to obtain additional evidence, higher quality evidence, or alternative forms of corroborating evidence; or aligning the findings and conclusions to reflect the evidence obtained.The auditor minimizes the audit risk to the level where his opinion on the financial statement is acceptable to all users. The auditor plans audit work with lowestperceived level of audit risk. The lowest level of audit risk is not quantified rather it is based on his judgment about the records prepared by the company. • Overall assessment at financial statement level (rate high, low, medium) • Assessment the account balance or class of transactions level (26/26)
  27. 27. Materiality is important to auditors because it has direct impact on the work to be done by them. Important note: Smaller the magnitude of misstatement that is considered to be important, the greater effort or work is required by the auditors to identify that no such misstatement exists.ISA 320 entitled Audit Materiality adopts the same definition as given in IASB’sFramework for the preparation and presentation of financial statements, viz: ”Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.” This definition does not provide a basis for quantifying the amount of misstatement that is important for a specific audit engagement. This definitionmakes it a subjective issue for an auditor. As a result, many different quantitative bases are used in determining the appropriate magnitude for materiality. Most commonly used bases of materiality are: • Total Assets • Net Income • Net Assets • Current Assets • Sales • Gross MarginThe percentage approach to define materiality for assets and profits must be dealt with care because underlying assumptions vary from company to company andsector to sector. An item may be material because of its nature, value and impact. The assessment of materiality at planning stages should be based on the most recent and reliable financial information. (27/26)
  28. 28. Quick Points about Materiality: • It is an expression of the relative significance of a particular matter in the context of financial statements as a whole. • It is based on judgment of an auditor. • It can be changed as audit work progresses depending on the results of initial procedures. • Materiality is related with the true and fair view concept. • A matter is material if its omission or misstatement would reasonably influence the decisions of the users of the financial statements. • Materiality has both qualitative and quantitative aspects. • Materiality defines the nature, timing and extent of work required by the auditor in order to express his opinion on the financial statements.Para 15 of ISA 320 goes like this,“If management refuses to adjust the financial statementsand the results of extended audit procedures do not enablethe auditor to conclude that the aggregate of unrecordedmisstatements is not material, the auditor should considerthe appropriate modification to the auditor’s report inaccordance with ISA 701.” (28/26)