Materiality in Government Auditing

By Raman, K. K.; Van Daniker, Relmond P. | Journal of Accountancy, February 1994 | Go to article overview

Materiality in Government Auditing


Raman, K. K., Van Daniker, Relmond P., Journal of Accountancy


Current practice regarding materiality in government audits under generally accepted auditing standards, Government Auditing Standards (the yellow book) and the Single Audit Act of 1984 varies widely. Do government auditors agree on an appropriate base for calculating materiality? What percentages do they apply against the materiality bases? To answer these questions, we conducted a study of current practices, which was sponsored by the National Association of State Auditors, Comptrollers and Treasurers (NASACT) and funded by Ernst & Young. This article reports the findings and reviews the basic concepts of materiality in the context of government auditing.

The yellow book incorporates American Institute of CPAs audit standards including Statement on Auditing Standards no. 47, Audit Risk and Materiality in Conducting an Audit. These standards do not provide quantitative guidelines (appropriate bases and percentages) for calculating materiality. Our study provides information about materiality levels implicit in current practice and can be valuable to auditors in audit planning and performance evaluation.

In a government context, the probability of client financial failure (and subsequent discovery of material financial statement misstatements) is unknown or very low. This relatively stable environment is characterized by competitive audit pricing practices and, in general, an undue emphasis on price in auditor selection. Consequently, the need for materiality guidelines (as a possible standard for an audit's sufficiency) may be greater in government than in a corporate context.

While guidelines cannot substitute for professional judgment, they can be a starting point. The conclusion of this article provides a sliding-scale materiality guideline CPAs can use to evaluate their professional judgments.

AN ACCOUNTING AND AUDITING CONCEPT

Financial Accounting Standards Board Concepts Statement no. 2, Qualitative Characteristics of Accounting Information, defines materiality as the magnitude of an omission or misstatement that, in the context of surrounding circumstances, would influence the judgment of a reasonable financial statement user. Thus, materiality refers to financial statements' level of precision or accuracy.

SAS no. 53, The Auditor's Responsibility to Detect and Report Errors and Irregularities, and SAS no. 54, Illegal Acts By Clients, require an audit to be designed to provide reasonable assurance of detecting material financial statement misstatements (material errors and irregularities) and illegal acts that may have a direct and material effect on financial statement amounts. The phrase "present fairly" in the auditor's opinion incorporates the concept of materiality by suggesting the financial statements are accurate only within reasonable and practicable limits.

Audit service contracts typically are silent on the level of materiality to be applied or achieved. In the absence of quantitative guidelines, it is reasonable to expect nonuniformity in practice. At least 10 different published (but nonauthoritative) quantitative materiality guidelines are found in corporate professional literature, providing materiality amounts that vary widely for the same type of audit. It appears that although the result of the audit process (the audit opinion) is standardized, the key ingredient of materiality (which is invisible to financial statement users) can vary across audits.

The concepts discussed above are incorporated by reference in General Accounting Office (GAO) standards. Although additional compliance reports are required, the auditor need not perform additional tests beyond those performed to issue an opinion on the financial statements.

An organizationwide audit under the Single Audit Act expands the scope of the traditional financial statement audit significantly by requiring auditors to express an opinion on compliance with laws and regulations applicable to major federal financial assistance (FFA) programs. …

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