What is materiality and steps in calculation and use of materiality?

Materiality refers to the threshold or cutoff point at which an item or issue becomes significant enough to warrant attention from the auditor or financial statement preparer. In other words, it is the level of significance at which the information would be likely to influence the decisions of users of the financial statements.

The calculation of materiality is typically based on a percentage of the total assets or revenue of a company. For example, a common threshold for materiality might be 5% of total assets or revenue or profit before tax. However, the exact percentage will vary depending on the specific circumstances of the company and the industry in which it operate.

There are several steps involved in the calculation and use of materiality:

1. Determine the financial statement line item(s) or account(s) to be considered.
2. Identify the total assets or revenue of the company.
3. Establish a materiality threshold, typically as a percentage of total assets or revenue or profit before tax.
4. Identify any items or issues that exceed the materiality threshold.
5. Evaluate the impact of these items or issues on the financial statements and communicate any necessary adjustments to the financial statement users.
6. Review the materiality threshold on a regular basis, as the company's financial condition may change over time.

In audit, the materiality is used by auditors to decide the nature, timing, and extent of audit procedures. It is used to identify and assess the risks of material misstatement in the financial statements and to design and perform audit procedures responsive to those risks.

It is also used in financial reporting to evaluate the importance of information that should be disclosed in the financial statements. The materiality concept is used to determine the level of detail required in the financial statements and the notes to the financial statements.

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