Answer to question 1a):
Materiality concept has a long history in auditing and accounting jurisdiction and they form a crucial part of the accounting. Materiality is said to occur when there is misstatement or omission of information that might lead to influencing users decision making that is based on the financial statements presented. Amount and nature of items that is judged in certain circumstance of omission or misstatement forms the basis of materiality. Consideration of concept of materiality is somewhat difficult because of its pervasive nature except when it is related to faithful representation and relevance characteristics. Whether the decision of users is sufficiently influenced by information is determined by materiality and hence it is regarded as filter or screen (globalreporting.org, 2017). The decision making process of some actual and potential users is dependent upon whether the information presented in financial statement is material or not. Decision usefulness on other hand, is considered as one of the objectives of financial reporting as identified by International Accounting standard board. An information is considered useful for decision when it assist users by providing them information that is useful for making investment in any particular entity. Decision usefulness is regarded as an important part of framework on which reporting standards are developed. Approach of decision usefulness is about preparing financial accounting information by creating emphasis on decision making theory of investors for deducing nature and types of information’s required by investors (Nobes, 2014).
Decision usefulness is required for satisfying the information needs of users of financial statements. Reliability and relevance of information is required under the approach of decision usefulness. It has the organizing criteria for accounting scholarship and accounting policies for almost forty years. Useful of decision making is one of the most important quality of accounting information. Usefulness is a qualitative e characteristics because if there is no usefulness of information, the users will not be benefitted from such information to set against their costs. Materiality is a pervasive concept that is relative to qualitative characteristics such as reliability and reliance as they tend to make some difference to decision makers. It is stated by GAAP, US that material items are those that are important enough to influence decisions of users and users can be misled if there is any materiality errors. Therefore, it can be said that materiality and approach of decision usefulness are interrelated. Decision usefulness of financial statements of users are explicitly addressed in definition of materiality provided by FASB (Hahn & Kühnen, 2013). Disclosures of information in financial statements is related to the application of materiality. Information will be reliable if it is free from any materiality errors and therefore, decision taken by users of financial statement will be reliable and useful. Materiality and decision usefulness are related to one another as decisions are reliable when the materiality have been properly assessed. Decisions of investors are dependent upon materiality factor and hence useful decision is dependent upon materiality (Warren, 2016).
Answer to question 1b):
One of the most critical concepts in accounting is that of materiality in terms of accounting and auditing of financial statements. In earlier, materiality was understood in quantitative terms and later on a notion of qualitative materiality was introduced. In this regard, if any financial activities are not significant due to its illegality, then they are regarded as material. With passing of times, numerous methods were developed to assess the materiality of any item presented in the financial statement.
It has been ascertained by establishing relationship between materiality and rotation of auditors that judgment of auditors can be impaired if there is long-term affiliation with audit clients. Application of concept of materiality into the financial reporting framework provides them with flexibility. Materiality often determines the items that are disclosed in financial statement. Judgment that exercised around materiality forms a content in the financial statements. Designing of audit procedures and audit planning also depends upon materiality concept as they have relevance in auditing. Choice of materiality level that is designed in audits is determined by extent of auditing (Weil et al., 2013). They have importance in financial statements evaluation and whether they comply with generally accepted accounting principles.
The operations of materiality has also been found in making judgment by investors as the stock price movement tends to get influenced by such factors. Materiality judgment of investors is reflected in capital market strength and it response as implied by announcement such as equity for debt swaps. Some of important economic effects on stock price might be due to materiality of immaterial adjustments to earning. Evidence of impact of accounting misstatement on decision of users is depicted by providing evidence of relationship between price of stocks and earnings. Materiality concept has been operationalize to make the enhancement of transparency in accounting and auditing (Fonseca et al., 2014). Options for having appropriate base for materiality calculation influences the choice of materiality. Measure of income is regarded as the most common based for materiality assessment. Materiality of items are assessed against using alternative benchmark such as profit making firm income and total assets. The application of materiality might be misinterpreted by shareholders and this is because of lacking understanding in calculating materiality by reference to current period income and normal income (Erb & Pelger, 2015). It is argued by them that determination of materiality of items should be done by referring to income of current period as they are likely to influence decision of financial statement users.
Materiality has been regarded as multiple curse of knowledge having several roles such as solution to over auditing issue, moral responsibility and financial reporting foundation. They are interpreted as a performative activity that is at the crux of genuine games such as making, controlling, taming and hiding errors of translation in accounting inscription (Eisenschmidt & Schmidt, 2016). Operations of materiality in accounting framework is done in such a way that it leads to production of high quality financial reporting information.
References list:
Eisenschmidt, K., & Schmidt, M. (2016). Responsiveness as a Challenge for the Legitimacy of the IASB-An Evaluation of Current International Accounting Regulation and of Alternative Approaches.
Erb, C., & Pelger, C. (2015). “Twisting words”? A study of the construction and reconstruction of reliability in financial reporting standard-setting. Accounting, Organizations and Society, 40, 13-40.
Fonseca, A., McAllister, M. L., & Fitzpatrick, P. (2014). Sustainability reporting among mining corporations: a constructive critique of the GRI approach. Journal of Cleaner Production, 84, 70-83.
Global Reporting Initiative Search . (2017). Globalreporting.org. Retrieved 8 December 2017, from https://www.globalreporting.org/search/Pages/default.aspx?k=decision%20usefulness
Hahn, R., & Kühnen, M. (2013). Determinants of sustainability reporting: a review of results, trends, theory, and opportunities in an expanding field of research. Journal of Cleaner Production, 59, 5-21.
Nobes, C. (2014). International Classification of Financial Reporting 3e. Routledge.
Warren, C. M. (2016). The impact of International Accounting Standards Board (IASB)/International Financial Reporting Standard 16 (IFRS 16). Property Management, 34(3).
Weil, R. L., Schipper, K., & Francis, J. (2013). Financial accounting: an introduction to concepts, methods and uses. Cengage Learning.
