Materiality Defined: Differing Concepts of Materiality Can Cause Confusion Among Stakeholders

Because the term materiality arose within the context of financial reporting and statement assurance, internal auditors have been challenged in adapting or creating a definition that is relevant for themselves and their stakeholders. In the context of financial reporting, materiality is relevant to three stakeholder groups: 1) preparers of financial statements, 2) auditors, and 3) users of financial statements. Although materiality decisions are made by only two of these three groups--preparers and auditors--most internal auditors\u27 conception of materiality likely has a user orientation. The auditor might ask, How would a reasonably prudent investor react to the magnitude of misstatement (under- or over-reported amounts) or omission of a specific financial statement item in terms of its presentation and disclosure? Given this backdrop, the term materiality can be a significant cause of confusion in determining what to audit, how much to audit, what to correspondingly report, and for what matters it is necessary to gain consensus regarding management action. In many situations, stakeholders come to the table with their own concept of materiality--sometimes vaguely defined--that can be at odds with internal audit\u27s definition. Sometimes managers attempt to mitigate or downplay an issue and internal audit\u27s proposed recommendation because it reflects poorly on their performance in their respective areas of responsibility. In such instances, supposed lack of materiality can be used as the basis for an argument to convince internal audit that the issue under discussion has no real merit. If internal auditors are not well-prepared to articulate and defend what they believe to be the relevant concept of materiality, the discussion of audit issues can easily become contentious or seriously impaired. It is therefore imperative that internal auditors fully understand the meaning and contexts of the term materiality so they are prepared to use it authoritatively and appropriately