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. AAS13 on Audit Materiality lays down standard on the concept of materiality and its relationship with audit risk. (Students may note that there is AAS-6 on Audit Risk). AAS-13 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
“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. In many cases percentage comparison may be useful in indicating the materiality of an item. For example, Part II of Schedule VI to the Companies Act, 1956 requires that any expense exceeding one per cent of the total revenue of the company or Rs. 5,000 whichever is higher, shall be shown as a separate and distinct item under an appropriate account head in the profit and loss account and shall not be combined with any other item to be shown under miscellaneous expenses. Similarly, if an item account for 10% or more of the total value of raw material consumed, it has to be shown separately and distinctively. Further, Part II of Schedule IV also requires that profit and loss account shall disclose every material feature including credits or receipts and debits or expenses in respect of non-recurring transactions or
transactions of an exceptional nature. Actually the detailed disclosure requirements of Schedule VI to the Companies Act, 1956 seek to ensure that the financial statements disclose all material items so as to give a true and fair view of the state of affairs of the company. 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 :
- 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
- on its comparison with the corresponding
figure of the previous year. In many circumstances even small amount may be considered material. Thus, if there is a statutory requirement of disclosure of amount paid as sitting fee to directors the amount so paid must be disclosed precisely and separately. Similarly, a payment of Rs. 100 to directors as remuneration in excess of statutory limits may be material. A small inaccuracy may be considered material if it further depresses or boosts a low profit or converts a small loss into a profit or vice versa. Similarly, if it creates or eliminates a margin of insolvency in the balance sheet, it will be a material item.
Transaction of abnormal or non-recurring nature are also considered material even though the amount involved may not be significant. In off-setting and aggregating items, care must be taken to see that items which are independently material are not set-off against each other. For example, the surplus arising from a change in the basis of accounting may not be set-off against a non-recurring loss. Even as item with a nil or small balance may assume materiality in a situation where it was not expected to be nil or insignificant.
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 atleast clear information about the item is available in the accounting statements.