TRUE AND FAIR VIEW, MATERIALITY AND JUDGEMENT

True and Fair View

The concept of “true and fair view” occupies a central place in financial
reporting. The concept which has been debated over time has a powerful, direct
effect on accounting practice and it is the ultimate test for financial statements.
The Companies and Allied Matters Act requires the auditors to include in their
report whether the financial statements show a true and fair view of the affairs
of the entity at a balance sheet date. The auditing standards also put the concept
of “true and fair view” in perspective.
The “true and fair view” is a dynamic concept in that, over time, the concept
has always moved in sympathy with changes in accounting and business
practice. The more the laws change and the more accounting and auditing
standards change, the more the requirements which the auditor must meet to
ensure the financial statements upon which he or she is reporting, meet the
concept of ‘true and fair’ view. The concept affects the interpretation of the
components of financial reporting and comes to play in setting procedures for
the conduct of audit in an accounting practice.
It is important to note that financial statements will not give a “true and fair
view” unless the information they contain is sufficient in quantity and quality
to satisfy the reasonable expectations of the readers to whom they are addressed.
The concept of “true and fair view” influences accounting standards and other
authoritative pronouncements.

Materiality

The APB Statement of Auditing Standard 220 covers ‘Materiality and the audit’.
The International Auditing and Assurance Standards Board of IFAC issued
International Statement on Auditing 320 on ‘Audit Materiality’.
The International Statement on Auditing on Audit Materiality states that
information is considered to be material to the financial statements if the
misstatement or omission of such information may reasonably be expected to
‘influence the economic decisions of users’ of those financial statements,
including their assessments of management’s stewardship.
Auditors must consider the effect of possible misstatement of relatively small
amounts in that a relatively small error in a month end procedure may be an
indication of possible material misstatement when the cumulative effect on
the financial statements is considered at the end of the financial period.
A misstatement or the aggregate of all misstatements in financial statements
is material if, considering the surrounding circumstances:
(a) It is probable that, the decision of a person who is relying on the financial
statements; and
(b) Who has a reasonable knowledge of business and economic activities
(the user), would be changed or influenced by such misstatement or the
aggregate of all misstatements.
Steps in establishing materiality
The steps to be followed in establishing materiality of an audit item are:
(a) Set a threshold at the planning stage about materiality;
(b) Record misstatements identified in the course of the audit; and
(c) Document the likely misstatements and compare with materiality.
When immaterial information is given in the financial statements, the result
may distort the understandability of the other information provided. In such
circumstances, the auditors need to consider the exclusion of such immaterial
information. However, the requirements of legislation, accounting standards
and auditing standards must be considered in determining the nature of
information to be given in the financial statements.

Principal factors affecting materiality

The auditor must exercise judgement in determining whether information is
material. An item may be material considering its size and nature. The principal
factors which may affect materiality are as follows:
(a) The size of the item when taken in the context of the financial statements
as a whole and of the other information readily available in the market
place to investors and users that would affect their evaluation of the
financial statements;
(b) Consideration may be given to the nature of the item in relation to:
(i) the basis of transaction or other event giving rise to it;
(ii) the significance of the event or transaction;
(iii) the legality, sensitivity, normality and potential consequences of
the item; and
(iv) the disclosure requirement of such item.
The auditor should determine materiality by a combination of these factors,
rather than any one in particular. When there are two or more similar items,
the auditor should consider the aggregate.

Consideration of materiality

In planning the conduct of an audit, auditors seek to provide reasonable
assurance that the financial statements are free of material mis-statement
and give a true and fair view. Auditors exercise professional judgement in
determining what is material. Both the amount (quantity) and the nature
(quality) of mis-statements are considered in determining materiality. There
exists a difficulty in ascribing general mathematical definition to ‘materiality’,
in that it has both qualitative and quantitative aspects.
Auditors must consider the possibility of misstatements of relatively small
amounts that, cumulatively, could have a material effect on the financial
statements. For example, a relatively small error in a month-end procedure
could be an indication of a potential material misstatement, if that error is
repeated each month during the financial year that is being audited.
Auditors should also pay attention to the nature of mis-statements relating to
qualitative aspects of a matter. Examples of qualitative mis-statements would
be the inadequate or inaccurate description of an accounting policy when it is
likely that a user of the financial statements could be misled by the description.

Materiality and audit work

In planning and conduct of an audit, auditors must consider:
(a) Materiality and its relationship with audit risk; and
(b) Materiality when determining the nature, timing and extent of audit
procedures.
At the planning stage, the assessment of materiality based on the latest
available reliable financial information, assists in the determination of an
efficient and effective audit approach. The preliminary materiality assessment
helps auditors decide such questions as what items to examine, and whether
to use sampling techniques. This enables auditors to select audit procedures
that, in combination, reduce audit risk to an acceptably low level.
In practice, the assessment of materiality at the audit planning stage, may
differ from that at the time of evaluating the results of audit procedures. This
may be caused by a change in circumstances, or a change necessitated by the
outcome of the audit. For example, if the actual results of operations and
financial position are different from those they expected when the audit was
planned.
Auditors must consider the implications of factors which result in the revision
of their preliminary materiality assessment on their audit approach. In this
circumstance, auditors may modify the nature, timing and extent of planned
audit procedures. For example, if, after planning for specific audit procedures,
auditors determine that the acceptable materiality level falls short of the initial
materiality level, the risk of failing to detect a material mis-statement
necessarily increases. The risk may be compensated for by the auditors carrying
out more audit work.

Evaluating the effect of mis-statements

In evaluating whether the financial statements give a true and fair view,
auditors should assess the materiality of the aggregate of uncorrected misstatements.
The following constitute aggregate of uncorrected mis-statements:
(a) Specific mis-statements identified by the auditor, including uncorrected
mis-statements identified during the audit of the previous period if they
affect the current period’s financial statements; and
(b) Auditors’ best estimate of other mis-statements which cannot be
quantified specifically (for example projected errors).
The auditor must consider whether the aggregate of uncorrected mis-statements
is material. If the auditor concludes that the mis-statements may be material,
the auditor should consider reducing audit risk by extending audit procedures
or requesting the directors to adjust the financial statements. If the directors
refuse to adjust the financial statements and the results of extended audit
procedures do not enable the auditor to conclude that the aggregate of
uncorrected mis-statements is not material, the auditor should consider the
implications in the preparation of his or her report.

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