Materiality in the financial audit

The audit of an annual account must be planned and carried out in such a way that significant errors are detected. Materiality in this context represents a threshold within which the annual account can be confirmed unconditionally despite errors.

Quantitative and Qualitative Materiality

Materiality has both a quantitative and a qualitative dimension. From a quantitative perspective, an error may be so large that it does not influence the economic decisions of the current and future shareholders. The materiality limit here is a relative size to accommodate different company sizes.

From a qualitative perspective, information is material if its omission or misrepresentation could influence an economic decision of the reader of the financial statements. This is the case, for example, if the company is over-indebted or if there is a capital loss with legal consequences that are not disclosed, or if a profit is reported although a loss was incurred. For reasons of clarity, materiality is not only a minimum requirement but also a maximum requirement: immaterial things should be omitted.

Determination of Quantitative Materiality

The determination of materiality lies within the discretion of the auditor and depends on the information needs of the financial statement recipients. As a starting point for the calculation, a selected reference size and a corresponding percentage with which the reference size is multiplied is used. Thus, materiality can be set as 5% of the net profit, 3% of total sales, or 0.5% of the balance sheet total, to name a few examples from practice.

The lower the materiality is set, the higher is the audit risk, i.e., the probability that an annual account is essentially described as error-free, although it contains significant errors. The level of materiality thus decisively determines the scope, duration, and therefore the costs of an audit.

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