Importance of Materiality in Audit

In planning of each audit, auditors shall consider the materiality for the purpose of audit. Information is considered as material if misstatement or omission of particular information can influence the user’s economic decision taken on the basis of the financial report. Materiality is depended upon the size of item or error judged in specific circumstances of the misstatement or omission of that item.  Hence, materiality provides the cut-off point or threshold, rather than just being the qualitative characteristics. One the auditor is able to establish the materiality they shall set the level for performance materiality that is the tolerable misstatement for the financial report of the client. However, the planning materiality level more than the performance materiality level (Amiram et al., 2017).

In the given scenario it is stated that the Cloud 9 Pty Ltd’ main business is delivering athletic shoes to its leading customers David Jones, Myer, rebel Sports and Foot Locker. Recently the entity engaged W&S Partners, an Australian based accounting firm for carrying out its audit. The auditor started the audit with planning the materiality level involved with the financial reports of the entity. Though various items like revenues, total asset, gross profit, equity and profit before tax can be taken into consideration for establishing the materiality level, generally any single base is selected for financial report as a whole (Audsabumrungrat, Pornupatham & Tan, 2015). This single base can be 2% of gross profit, 1% of total equity, 0.5% of total turnover, 0.5% of total assets, or 5% of profit before tax. Profit before tax is considered as the most acceptable base for establishing the level of materiality unless the profit is radically influenced by any specific transaction or the company could not generate any positive earnings for the period. Looking into the income statement of the company it can be noticed that the one amount of disposal proceeds involves significant amount that increased the profit of the company significantly by 15,76,859. Therefore, profit base cannot be considered for establishing the materiality level (Barndt, Fuller & Flynn, 2016). Next item that can be considered for the purpose of materiality establishment is total asset. 0.5% of total asset of the company that is (32,864,958 * 5%) = 164,324.79 will be established as level for planning materiality. However, 50% to 70% of the planning materiality on the basis of the risk level of the financial report is used for computing the level of tolerable misstatement. Lower level of risk will lead to less number of individually significant items those will be required to audit 100% (Lakis & Masiulevi?ius, 2017). 

Analytical procedures of audit assists in recognising the possible issues involved with the financial reports of the client that can be investigated more precisely. It involves comparison of different financial reports and the operational information to assess the variation taken place in the current period’s financial reports with the part periods. Auditors of Cloud 9 Pty Ltd can use ratio analysis approach as a tool for analytical procedure.

Establishing Materiality Level

Liquidity ratio – liquidity position of the entity shall be analysed to assess whether the entity has sufficient liquid asset to pay off the obligation due within the period of one year. Current ratio assesses the amounts of current assets against the current liabilities. However, the quick ratio is stricter and dies nit consider the assets those take time to convert into cash like inventories. Both the current ratios have improved in 2017 as compared to previous year. Hence, the liquidity position of the entity is not an area of concern (Greco, Figueira & Ehrgott, 2016).

Leverage ratio – leverage position or solvency status of the entity shall be analysed to assess whether the entity is sustainable over the long term period. It is analysed through comparing the debt component of capital structure with equity. Both the leverage ratio of the company that is debt equity ratio and debt ratio of the entity have improved in 2017 as compared to previous year. Hence, the solvency position of the entity is not an area of concern (Williams & Dobelman, 2017). .

Profitability ratio – profitability position of the entity shall be analysed to assess whether the entity is able to generate sufficient revenue to pay off its operational expenses and generating earnings for its shareholders. Looking into the gross profit margin as well as the net profit margin of the entity it can be stated that through the gross profit slightly reduced in 2016 the net profit has improved in 2017 as compared to previous year. Hence, the solvency position of the entity is not an area of concern.

Efficiency ratio – efficiency of the entity shall be analysed to assess whether the entity is efficient in selling its inventories and collecting its receivables on time. Both the inventory turnover ratio and receivable turnover ratio of the entity has been slowed down in 2017 as compared to 2016 that indicates the inefficiency of the company. Hence, the efficiencies of the entity are definitely an area of concern (Williams & Dobelman, 2017).

From the above analysis it can be found out that the various areas those shall be specially emphasised by the auditor are cash, revenues, inventories and trade receivables. If the analytical procedure through ratio analysis is considered, it can be identified that the concern areas are efficiencies of the company that includes inventories, trade receivables and associated item credit sales that is revenues. Further, cash shall be selected as it is always vulnerable to fraud risk as it is the most liquid asset (Uechi et al., 2015).

Purpose of this report is looking into the information related to executive’s remuneration paid by different ASX listed entities. For this report 3 entities those will be considered for analysing are Evolution Mining, Altura Mining and Rio Tinto Plc. All these 3 entities are the leading mineral companies from Australia those are listed under ASX. The report will focus on the basis on which these companies provide remuneration to their executives and whether the remuneration is linked with the profit of the company or any performance measure (Alturamining.com, 2019).

Payment system of the executives

Evolution Mining – executive remuneration are based on the following –

• For CEO – 33% of the total remuneration is TFR (total fixed remuneration), 20% of the total remuneration is STI (short term incentives) and 47% of the total remuneration is LTI (long term incentives).
• Other senior executives – 38% of the total remuneration is TFR (total fixed remuneration), 23% of the total remuneration is STI (short term incentives) and 39% of the total remuneration is LTI (long term incentives).
• STIP includes cash bonus up to the maximum % of the TFR on the basis of job band of the employee
• LTIP includes ECOP (Employees and Contractors Option Plan) and ESOP (Employee Share Option and Performance Rights Plan) (com.au, 2019).

Altura Mining – executive remuneration are based on the following

• Primary benefits including the fees, salaries, non monetary benefits that includes the provision for motor vehicle
• Performance right on equity and the share option that is granted under the long term incentive plan including ESOP and LTIP.
• Post employment benefits that include stipulated retirement benefits and superannuation benefits (com, 2019).

Rio Tinto Plc – executive remuneration are based on the following

• Base salaries including fixed element of remuneration package
• Superannuation or pension including participation in superannuation fund or pension fund
• Other benefits including healthcare cover for executives and their dependents, car parking, car allowance, life insurance, professional advice, minor benefits and accident insurance.  
• STIP – 25% maximum for performance threshold, 50% for target and 100% for the outstanding performance
• Bonus deferral – 50% of STIP
• Performance share award under LTIP (com, 2019). 

Higher level of payment

Rio Tinto	Altura Mining	Evolution Mining
$ 36,86,000.00	$ 19,48,603.00	$     100,04,112.00

From the above table it can be identified that Evolution Mining paid highest amount of remuneration to its executives amounting to $ 100,04,112.00.

Remuneration linked profit or share price performance –

Evolution Mining – the company pays the STIP on the condition upon achievement of the key objectives of the company and the individual KPIs.  Further, LTIP is paid on the basis of market price of the share (Evolutionmining.com.au, 2019).

Altura Mining – executive’s remuneration package of the entity is not linked with profitability or share performance of the entity. However, LTIP is maintained by the entity for granting the share options and performance rights (Alturamining.com, 2019).

Rio Tinto Plc – the remuneration policy of the entity is linked with the performance target for STI and LTI. It is lined up with the performance to provide sustainable growth of the entity over ling term period to generate shareholder’s value and company’s strategic policies (Riotinto.com, 2019).

Hence, it can be determined that Evolution Mining’s executive remuneration is mostly linked with profit or share price performance of the company.

Conclusion 

It can be concluded on the basis of above discussion that Australian entities pays remuneration to its executives that includes base salaries, STIP, LTIP and other benefits like insurance benefits and car benefits. However, some of the entities pay remuneration on the basis of company’s profit or share performance.

Reference

Alturamining.com., (2019). Altura Mining | Charging Forward with Lithium. Retrieved 30 January 2019, from https://alturamining.com/

Amiram, D., Chircop, J., Landsman, W.R. & Peasnell, K.V., (2017). Mandatorily disclosed materiality thresholds, their determinants, and their association with earnings multiples.

Audsabumrungrat, J., Pornupatham, S. & Tan, H.T., (2015). Joint Impact of Materiality Guidance and Justification Requirement on Auditors’ Planning Materiality. Behavioral Research in Accounting, 28(2), pp.17-27.

Barndt, R.J., Fuller, L.R. & Flynn, K.E., (2016). Teaching Inherent Risk and Tolerable Misstatement in Auditing: A Modified Delphi Method as a Teaching Tool. In Advances in Accounting Education: Teaching and Curriculum Innovations(pp. 125-140). Emerald Group Publishing Limited.

Evolutionmining.com.au. (2019). Evolution Mining – Australian Gold Company. Retrieved 31 January 2019, from https://evolutionmining.com.au/

Greco, S., Figueira, J. & Ehrgott, M., (2016). Multiple criteria decision analysis. New York: Springer.

Lakis, V. & Masiulevi?ius, A., (2017). Acceptable Audit Materiality For Users Of Financial Statements. Journal of Management, 2(31).

Riotinto.com., (2019). Global home. Retrieved 30 January 2019, from https://www.riotinto.com/our-business-75.aspx

Uechi, L., Akutsu, T., Stanley, H. E., Marcus, A. J., & Kenett, D. Y. (2015). Sector dominance ratio analysis of financial markets. Physica A: Statistical Mechanics and its Applications, 421, 488-509.

Williams, E. E., & Dobelman, J. A. (2017). Financial statement analysis. World Scientific Book Chapters, 109-169.