As audit season begins for calendar-year entities, it’s important to review issues that may arise during fieldwork. One common issue is materiality. This concept is used to determine what’s important enough to be included in — and what can be omitted from — a financial statement. Here’s how materiality is determined and used during an external financial statement audit.
What is materiality?
Under U.S. auditing standards and Generally Accepted Accounting Principles (GAAP), “The omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is probable [emphasis added] that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.” This aligns with the definition of materiality used by the U.S. judicial system. However, it differs somewhat from the definition set by the International Accounting Standards Board. Under International Financial Reporting Standards (IFRS), misstatements and omissions are considered material if they, individually or in the aggregate, could “reasonably be expected to influence the economic decisions of users made on the basis of the financial statements.”How do auditors determine the materiality threshold?
Auditors rely on their professional judgment to determine what’s material for each company, based on such factors as:- Size,
- Industry,
- Internal controls, and
- Financial performance.
