Auditing: Materiality, Independence, and Internal Control Weaknesses at Everyday Supplies

AUDITING
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AUDITING
Question 1
1. Australia first introduced an accounting standard dealing with materiality in 1969.The first
standard on materiality was issued by Australia’s Institute of Chartered Accountants as a
professional standard. The standard could notably not be enforced legally as it was a professional
standard that was only meant to provide guidance in the preparation of financial statements.
In1995, the AASB issued a legally enforceable standard; AASB 1031. The 1995 standard define
materiality, explained the role of materiality in making decisions relating to the preparation and
presentation of financial statements and required standards contained in other Accounting
standards to be effected if they had a material effect.
AASB 1031 was revised in 2004. There were no significant changes to the existing standard. The
revision was implemented on the backdrop of the adoption by the AASB of the International
Accounting Standards (IASs) issued by the International Accounting Standards Board (IASB). In
the adoption, IASs would be given priority over AAS if there were differences between the two
as the objective of the adoption was to ensure that AASB standards conform to international
standards. The revision implemented in 2004 involved reducing guidance on materiality as it was
noted that AASB had significantly more guidance on materiality compared to the international
Framework for Preparation of Financial Statements. However, the revision retained AASB
1031’s explanation of the meaning of materiality. AASB 1031 was further revised in 2013. The
revision removed guidance on materiality that was not contained in the IFRS. The revision also
directed constituents to other standards that provide guidance on materiality. The 2015 revision

of AASB 1031 completed the withdrawal of all references to the standard. The implication of the
2015 revision was that AASB 1031 was officially withdrawn.
2.
a. IAASB 1031 defined materiality as “ information which if omitted, misstated or undisclosed
could potentially adversely affect decisions relating to allocation of resources made by users
relying on financial reports or accountability of management or entity’s governing body”
(paragraph 5) With the adoption of IFRSs, AASB 1031 was revised and a new definition of
materiality was issued. The new definition defined omissions or misstatements as material if
“they could individually or collectively influence the economic decisions of users taken on
the basis of the financial statements. Materiality depends on the size and nature of the
omission or misstatement judged in the surrounding circumstances. The size or nature of
the item, or a combination of both, could be the determining factor.”(IASB 2007 p.5)
b. Under AASB 1031 materiality is determined based on two criteria: size and nature.
Quantitative guidelines provide guidance on how to determine materiality based on size while
qualitative guidelines relate to nature. The essence AASB’s quantitative guideline on materiality
is that an item or a collection of items is considered to be material if they are equal to or greater
than 10% of an appropriate base amount unless there is evidence to the contrary or a convincing
argument. Additional AASB 1031 quantitative guidance is that items that are individually or
collectively lest than 5% of a suitable base may be presumed not to be material unless there is
evidence to the contrary. Amounts greater than 10% are material while amounts less than 5% of
a base are immaterial. The standard is notably mum on the classification of items falling between
5% and 10% (PCAOB, 2007). Items or transactions may also be material if they are abnormal by

nature. Items that do not qualify to be classified as material under the quantitative guidelines may
be classified as material if their abnormality could affect the entity’s operating profit or loss after
tax.
c. Material misstatements and errors potentially affect the quality of work that auditors do.
Auditors should therefore plan their audits with the objective of detecting misstatements that
could lead to an incorrect audit opinion being reached. Auditors assess the risk that the clients
financial statements are false and based on this risk determine the level of materiality. If a
client’s level of risk is assessed to be high, then the auditor lowers materiality (Heiman-Hoffman,
Moser, and Joseph 2015 p.770). Conversely, if the level of risk is assessed to be low, then the
auditor responds by increasing materiality.
3. It is important to point out that IASs rely on a principles based framework. The implication of
this with regard to materiality is that whereas standards do not expressly state materiality levels,
the principles involved in determining materiality are well understood. The focus under the
principles based framework is on why materiality is set in the first place and not merely on
whether or not materiality should be 10%. Auditors and accountants should justify reasons for
using a low or high level of materiality. Withdrawal of AASB 1031 will not bring disparity in the
assessment of materiality. The reason is that auditors have to appreciate the reason why
materiality is important in the first place; the reason is to test whether there are misstatements or
omissions in the financial statements that could significantly affect the accuracy, truth and
fairness of financial statements. With this objective in mind, auditors are free to determine
materiality levels based on assessed levels of risk. The ultimate goal is to determine whether the
financial statements are reliable.