Query No. 43
Subject: Consideration of materiality in the application of accrual basis of accounting.1 A. Facts of the
Case
1. A government
company is engaged in production of fertilisers and various nitrogenous
chemicals. The company
has four manufacturing units of which at present only
one is operational. The company also has six marketing centres for marketing
the company’s products. Besides its own products, the company is also engaged
in selling fertilisers and other ancillary products on consignment sales
basis/outright purchase basis.
2. As per
the accounting policy
of the company,
expenses incurred upto Rs. 25,000
relating to a future period are expensed in the current year.
3. The statutory
auditors of the
company, in their
report to the shareholders, commented
that the company
has not complied
with Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’,
issued by the Institute of Chartered Accountants of India, and section
209(3)(b)
4. According to
the querist, the
company has gone
through the accounting policies
of various companies
and in all
such cases, where companies have
policy to charge
expenditure upto a
certain amount, though relating
to a future
period in the
current period, none
of the auditors have issued a
qualified report.
B. Queries
5. The querist
has sought the opinion of the Expert Advisory Committee on the following
issues:
(a) Whether the
aforesaid accounting policy
of the company violates the provisions of AS 1 and section 209(3)(b) of the Companies Act, 1956.
(b) If the
answer to (a) above is in the affirmative, then how there C. Points
considered by the Committee
6.The
Committee notes that one of the major considerations governing the selection
and application of an accounting policy is ‘materiality’. The Committee notes
that AS 1
requires that “financial
statements should disclose all
“material” items, i.e., items the knowledge of which might influence the
decisions of the
user of the
financial statements”
7. The Committee
also notes paragraphs
3 to 7
of the Statement
on Standard Auditing Practices (SAP) 13, ‘Audit Materiality’, issued by
the Institute of Chartered Accountants of India, which state as below:
4. The objective
of an audit
of financial information
prepared within a framework of recognised accounting policies and
practices and relevant statutory requirements, if any, is to enable the auditor
5. The concept
of materiality recognises that some matters, either individually or in the
aggregate, are relatively important for true and fair presentation
of financial information
in conformity with recognised accounting policies and
practices. The auditor considers materiality
at both the
overall financial information
level and in relation to individual account balances
and classes of transactions. Materiality may also be influenced by other
considerations, such as the legal and regulatory requirements, non-compliance
with which may have a
significant bearing on
the financial information,
and considerations relating to
individual account balances
and relationships. This process may result in different levels of
materiality depending on the matter being audited.
6. Although the
auditor ordinarily establishes
an acceptable materiality level
to detect quantitatively material misstatements, both the amount (quantity) and
nature (quality) of misstatements need to be considered. An example of a
qualitative misstatement would be the inadequate or improper description of an
accounting policy when
7. The auditor
needs to consider the possibility of misstatements of relatively small amounts
that, cumulatively, could have a material effect on the financial information.
For example, an error in a month- end (or other periodic) procedure could be an
indication of a potential material misstatement if that error is repeated each
month or each
8. From the
above, the Committee is of the view that though ‘accrual’
9. The Committee
is also of the view
that materiality needs
to be determined under the
specific facts and circumstances of each company keeping in
view as to
how it affects
the financial statements
either individually or in the aggregate. Accordingly, levels of
materiality may be different in different companies. Also, since the assessment
of what is material is a matter of professional judgement, it is possible that
different professionals may reach different conclusions.
D. Opinion
10. On the basis of
the above, the Committee is of the following opinion on the issues raised in
paragraph 5:
(a) The
appropriateness of the accounting policy of the company as stated
in paragraph 2
above, would depend
upon the considerations of
materiality determined on
the basis of paragraphs 6 and 7 above. Accordingly, the
accounting policy in question would
be proper provided
it does not
cross the threshold of materiality.
(b) Since the levels of materiality may be different in different companies keeping in view their individual facts and circumstances, the auditors may reach different conclusions. Also, since the assessment of what is material is a matter of professional judgement, different professionals may reach different conclusions.
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