The concept of materiality is fundamental to the process of accounting. It covers all the stages from the recording to classification and presentation. It is, therefore, an important and relevant consideration for an auditor who has constantly to judge whether a particular item or transaction is material or not. SA-320 on Audit Materiality lays down standard on the concept of materiality and its relationship with audit risk. (Students may note that there is SA-400 on Audit Risk). SA-320 requires that the auditor should consider materiality and its relationship with audit risk when conducting an audit. Infact, the auditor would be required to assess materiality right from the stage of planning the audit till the final stage of reaching at his opinion. Obviously, an auditor requires more reliable evidence in support of material items. He also has to ensure that such items are properly and distinctly disclosed in the financial statements.
“Accounting Standard 1 defines, material items as relatively important and relevant items, i.e. “items the knowledge of which would influence the decisions of the users of the financial statements”. Whether or not the knowledge of an item would influence the decisions of the users of the financial statements is dependent on the particular facts and circumstances of each case. It is not possible to lay down precisely either in terms of specific account or in terms of amounts the items which could be considered as material in all circumstances.
Materiality is a relative term and what may be material in one circumstance may not be material in another. Therefore, the decision to judge the materiality of the item whether in the aggregation of items, presentation or classification of items shall depend upon the judgment of preparers of the account on the circumstances of the particular case.
Apart from the percentage criterion, the relative significance of an item has to be viewed from many angles while judging its materiality. It is generally felt that in respect of items appearing in the profit and loss account and having an effect on the profit for the year, materiality should be judged in relation to the group to which the asset or the liability belongs, for example, for any item of current asset in relation to total current assets and any item of current liability in relation to total current liabilities. Another angle to judge the materiality of the item can be to compare it with the corresponding figure in the previous year. Suppose the item is of a low amount this year but it was of a much higher amount in the previous year then it becomes material when compared to the corresponding figure of the previous year. Thus, materiality of an item can be judged : (a) from the impact that the item has on the profit or loss or on the balance sheet, or on the total of the category of items to which it pertains, and (b) on its comparison with the corresponding figure of the previous year.
Thus, materiality, is an important and relevant consideration for the auditor also because he has to evaluate whether an item is material in giving or distorting a true and fair view of financial statement. He also has to ensure that a material item is disclosed separately and distinctly or at least clear information about the item is available in the accounting statements.
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