Materiality is a threshold above which the misstatements or omissions in the Financial Statements could influence the economic decisions of the users of the FS. For statutory audits, materiality is a critical concept because auditors must assess the accuracy and completeness of financial statements to provide assurance to stakeholders, regulators, and the public.

Steps to determine the Audit Materiality :-

Who are the Users of Financial Statements?

We have to assess whether the company is operating in complex environment and what will be the impact of the same on the Audit Materiality. Different industries have varying levels of complexity, risk, and financial reporting requirements.

We have to identify the users of the financial statements such as shareholders, creditors, regulators, and other stakeholders and assess what are the KPIs (Key performance indicators) of the company for the users.

Understanding the Companies Industry and Complexity

We have to identify the users of the financial statements such as shareholders, creditors, regulators, and other stakeholders and assess what are the KPIs (Key performance indicators) of the company for the users.

Professional Judgement

While applying the professional judgement we need to consider the qualitative factors such as the company’s reputation, market position, and management integrity in addition to quantitative benchmarks.

Selecting Benchmarks

We have to assess what should be the benchmark and it can be total assets, total revenues, Profit before tax, or equity. In some cases where the company is operating under a Cost-plus model than the benchmark should be Total Cost.

Calculating Overall Materiality

We generally apply percentage ranging from 1% to 5% on the Benchmark for determining the Overall Materiality. Please consider the factors such as Prior Year Misstatements, whether this is first year audit of the entity than in that case we take lower percentage to be on the conservative side, Listed or PIE (Public interest Entity) Audits etc.

Calculating Performance Materiality (PM) and Clearly Trivial Threshold (CTT)

Performance Materiality is generally a % of the overall materiality ranging from 50% to 80% depending on various factors such as Prior Year Misstatements, Control environment, Errors are repetitive in nature etc. Performance Materiality is utilised for  

comparing with the Classes of Transactions and identifying the Significant Classes of Transactions (SCOTs).

Clearly Trivial Threshold as the name suggests is the threshold below which the misstatements are considered inconsequential to users of the financial statements.

Documenting the Rationale

As an auditor we have to document the entire steps how we determined the materiality in a separate working paper and in that we have to document the rationale behind taking the benchmark, utilizing a specific percentages etc.

Continuous Monitoring

Materiality is an ongoing process and it needs to be evaluated at various stages such as Planning, execution and completion of the Audit and we have to document if there is any change in the circumstances due to which our materiality has to undergo change.

Understanding materiality is imperative for auditors to ensure the reliability and integrity of financial reporting. By following a systematic approach to determine audit materiality, auditors can effectively focus their efforts on areas of greater significance, providing stakeholders with reliable financial information.

Thanks for taking time to understand about Materiality. Stay tuned for more insightful content on related topics.

Thank you

Vaibhav Dangayach