Materiality And Financial Audits
Now things get a bit fuzzy. What is a material error? An error, or other reporting problem, is considered material if knowing about the problem would affect the decisions of an average prudent investor. Thus, the concept of materiality is very subjective. However, it means that the auditors are not guaranteeing that the financial statements are absolutely correct—only that they are materially correct. If Ford Motor Company inadvertently overstated its sales by $1 million, would this be material? In 1996, Ford had approximately $140 billion of sales! A $1 million error in computing sales at Ford is like a $1 error in computing the pay of a person who makes $140,000 per year—not material at all!
A financial audit is not concerned with absolute precision, and it is not primarily looking for fraud on the part of the company’s employees. Even so, audits will detect material misstatements (i.e., fraud). Also, auditors are responsible for ensuring that internal control procedures (explained in Chapter 6) are in place to help prevent fraud. If fraud is widespread in a company, normal audit procedures should detect it.
Accounting majors take at least one and often two or more courses in auditing, to understand how to conduct an audit so as to detect material accounting problems. Obviously there is not enough time in this course to explain auditing techniques, but at least be aware that auditors do not review how the company accounted for every transaction. Along with other methods, auditors use statistical sampling to systematically review company records.
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