Which of the following is a reason to consider qualitative factors of materiality
Hans Hoogervorst | September 25, 2017 | Show The accounting concept of materiality means that only information that is important to investors needs to be included in the financial statements. Information about trivial matters can be excluded. Even though this sounds straightforward, applying the concept in practice is not always easy. Companies often find it difficult to decide what is material. Consequently, rather than exercising judgement about what to include in financial statements, they use the requirements in the International Financial Reporting Standards (IFRS) as if they are a checklist. This results in financial statements that comply with the accounting requirements but do not communicate information effectively to investors. The International Accounting Standards Board is working to make the communication of financial information more effective. Hence, helping companies to decide whether information is material is an important part of the Board’s Better Communication in Financial Reporting theme—our focus for the next few years. Concept of Materiality Whether information is material is a matter of judgement. The concept of materiality works as a filter through which management sifts information. Its purpose is to make sure that the financial information that could influence investors’ decisions is included in the financial statements. The concept of materiality is pervasive. It applies not only to the presentation and disclosure of information but also to decisions about recognition and measurement. When making materiality judgements, companies need to consider a range of facts and circumstances, including both quantitative factors (for example, how big the amount involved is) and qualitative factors (for example, the specific circumstances of the company). When the concept of materiality is not applied appropriately, it may result in disclosure of too much information (sometimes called clutter) or too little information. Practice Statement In order to reinforce the role materiality plays in the preparation of financial statements and help companies exercise judgement, we have published the IFRS Practice Statement 2, Making Materiality Judgements. It provides companies with guidance on making materiality judgements when preparing financial statements in accordance with IFRS Standards. This non-mandatory document gathers in one place all the IFRS requirements on materiality and adds practical guidance and examples a company may find helpful in deciding whether information is material. It also suggests a four-step process for companies to follow when preparing their financial statements. Applying that four-step process, a company:
In addition, the Practice Statement includes specific guidance on how to make materiality judgements on prior period information, errors, and covenants, and in the context of interim reporting. Changing Behavior Our Practice Statement is designed to promote positive changes in behavior, encouraging companies to exercise judgement when deciding what information to include in in their financial statements. For behavioral change to take place, however, it is important that companies, auditors and regulators work together towards the common goal of providing better information to investors. [toc-this] PrinciplesConcept of materialityMateriality is a fundamental concept in financial and compliance audit. It sets the level of deviation that the auditor considers is likely to influence the decisions of the intended users. In theory, deviations, or errors, are material if they, individually or aggregated with other errors, would reasonably affect the underlying audit conclusions or the decisions of the addressees of the audit report. Users of information in the EU context, who must be considered when determining materiality, are primarily the European Parliament and Council (in particular due to the discharge procedure) but also the Commission and other EU institutions, member state authorities, media and the general public. Given the variety of users, determining materiality is a matter of professional judgement. An item or group of items may be material due to their amount (quantitative materiality), nature or the context in which the deviation occurs (qualitative materiality). There is a relationship between materiality and the level of audit risk. Furthermore, this threshold serves as a determining factor both in the calculation of sample sizes for substantive testing and in the interpretation of the audit results achieved. Setting materiality limits helps the auditor to plan the audit so as to ensure that material deviations are detected by audit tests and resources are employed economically, efficiently and effectively. Auditing to a stricter (lower) materiality threshold requires more audit testing; however, the auditor must avoid “over-auditing" in areas that do not merit extensive work. Materiality in different phases of auditMateriality should be considered by the auditor during:
The auditor should document the materiality levels and changes made thereto during the audit. Quantitative materialityQuantitative materiality is determined by setting a numerical value. The numerical value is achieved by taking a percentage of an appropriate base, which both reflect, in the auditor's judgement, the measures that users of the information are most likely to consider important.
Qualitative materialityCertain types of misstatements or non-compliance, while not quantitatively material, may - because of their nature or because of the context in which they arise - be qualitatively material and thus have an impact on the audit conclusion reached. Qualitative materiality includes items that may be either:
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[/toggle] [/toggles] InstructionsECA materiality thresholdFor ECA, the threshold percentage is between 0,5% and 2%. While the choice is a matter of judgement, a threshold of 2% is generally used. Based on users’ expectations a different threshold may be applied. In addition to the threshold percentage, a ceiling may also be set in terms of the absolute amount. Reliability auditsIn case of consolidated annual accounts of the EU, the materiality for the financial statements as a whole is fixed at 2 % of the total amount of the liabilities. We determine a performance materiality level for each item of the balance sheet. We take into account the nature and extent of misstatements identified in previous years and expectations in relation to misstatements in the current period. We consider that misstatements of balance sheet items less than 50 million euro are not expected to have a material effect on the financial statements. We consider the cumulative impact of uncorrected misstatements on the accounts. Legality and regularity auditsIn legality and regularity audits the base is typically total expenditure or total revenue. For example:
Materiality and systems failures regarding non-complianceIt would not be appropriate to use the materiality threshold of 2% as the only benchmark in the context of systems failures regarding non-compliance. In fact, systems weaknesses may be a management risk without in themselves resulting in actual errors of non-compliance, or may be a risk to compliance without materialising. The quality or effectiveness of the internal control systems can be determined solely on the basis of the materiality threshold of 2% if the audit provided a reasonable assurance (for instance, based on sufficient tests of controls and/or substantive tests):
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