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2

Uploaded by

Erika Aguilar
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1.

Overall Financial Statements:

• Broad Application: This level of materiality applies to the financial statements as a


whole. It's the threshold used to determine if misstatements or omissions in any part of
the financial statements would influence the decisions of users (investors, creditors,
etc.). If the total of the misstatements exceeds this threshold, the entire set of financial
statements might be considered misleading or not fairly presented.

• General Focus: This type of materiality considers the aggregate impact on the financial
statements, ensuring that no part of the financial report is materially misstated in a way
that would distort the overall picture of the entity's financial health.

2. Specific Accounts or Transactions:

• Tailored Approach: For certain accounts or transactions, auditors apply a different level
of materiality. These are areas that, for various reasons, need particular attention
because of their nature, size, or the risks they pose.

• Factors Influencing Specific Materiality Levels:

o Legal, Regulatory, or Reporting Framework Considerations:

▪ Certain items might have heightened importance due to laws or


regulations, influencing users' expectations. For example, related party
transactions might be more sensitive because they could potentially
involve conflicts of interest, and regulators often require more detailed
disclosure.

▪ Management Remuneration and Governance Disclosures: Items like


executive compensation or governance structures are typically
scrutinized more closely to ensure compliance with regulations and
transparency, especially in publicly traded companies.

▪ Fair Value Estimates: If there is high uncertainty around estimating fair


values (such as for complex financial instruments), auditors might apply
a lower materiality threshold for those estimates to account for the risk
that users might be misled by inaccurate valuations.

• Industry-Specific Disclosures:

o Certain industries may have unique disclosures that are crucial for users. For
example, a pharmaceutical company might face additional scrutiny on research
and development (R&D) expenditures, as these are critical to understanding its
future potential and value.
o Sensitivity Analysis: For industries where the future value of assets or liabilities is
uncertain (like the oil or tech industries), auditors might set materiality levels
specifically for sensitivity analysis of estimates in financial statements, which
could significantly impact users' decisions.

• Business Focus or Significant Disclosures:

o If an entity has a major or notable part of its business, like a significant business
combination or a large segment disclosure, auditors may apply specific
materiality to these areas.

o For example, if a company has acquired a large subsidiary or entered a new


business segment, the details of that acquisition or segment might be crucial for
users to understand the entity’s financial position, leading to tailored materiality
thresholds for those sections of the financial statement.

• Key Disclosures for the Entity's Business:

o When users' focus is on specific disclosures (e.g., environmental liabilities in a


mining company), these disclosures might have a different materiality level. The
disclosure of these items could be pivotal in decision-making and therefore
require higher scrutiny.

Why Materiality Levels Vary for Specific Accounts or Transactions:

• User Focus: Some transactions or balances are more relevant to users because they
reflect more significant aspects of the company's financial health or future prospects.
These areas require greater attention to ensure that users have the information they
need to make informed decisions.

• Increased Risk: Specific areas, such as executive compensation, related party


transactions, or financial estimates with high uncertainty, may have increased risks of
misstatement or manipulation, which requires applying lower materiality thresholds for
accuracy and transparency.

In Practice:

• Example 1: For a technology company with substantial investments in intellectual


property (IP), an auditor may set a lower materiality threshold for the valuation of IP,
given the significant role it plays in the company's financial position and the uncertainty
in estimating its value.

• Example 2: In the case of research and development (R&D) costs for a pharmaceutical
company, auditors might pay special attention to how these costs are classified and
whether they are expensed or capitalized, as they are critical to the company's future
product development and success.
In summary, while overall materiality applies to the financial statements as a whole, materiality
for specific accounts or transactions is based on the nature, risks, and relevance of those items to
the users of the financial statements. Tailoring materiality levels in this way ensures that
auditors focus on the most critical areas where misstatements could significantly influence users'
decisions.

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