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Determination of materiality level of auditing using multiple Linear Regression.


From a viewpoint, accounting is known as an information system whose processes include recognition, measurement and transmission of financial information (information broadcasting) so as to provide the users the possibility of making mindful judgment and suitable decisions. In accounting, the transmission of financial information is done by financial reports. Financial statements are the final products, i.e. the main parts, of financial reports. The purpose of financial statements is the presentation of some information about the financial status and the results of institutional operations for a large number of the users who are going to make suitable economic decisions. The transmission of financial information to the users and suitable economic decision makings are both dependent on desirable, reliable and precise quality of such information. Financial information doesn't necessarily have precision because of estimation-based valuation of some transactions and also some problems in accounting allocations. Additionally, users' capabilities, regarding their knowledge and specializations, to comprehend and analyze financial information are different. Therefore, accounting is always confronted with measurement limitations and user' limitations. The presence of above-mentioned limitations unavoidably necessitates paying attention to the applied precision to prepare the information and the significance of revealing such information, that is, the concept of materiality in accounting.

On the other hand, being sure about desired quality of financial information and its reliability requires independent assessment of such information by qualified experts and auditors. The main role of independent audition is to accredit the financial statements and to strengthen the efficiency of information broadcasting in accounting process.

The role of accreditation is played by auditing the financial statements following audition norms and based on the auditor's remark on fair presentation of such statements and their accordance with all important aspects of accounting standards. The accounting standards necessitate audition to be planned and performed in a manner that it assures the absence of any mistakes or deviations related to the concept of materiality in the financial statements.

The concept of materiality and its effect on auditors' comments are still vague although they are applied extensively. The carried out investigations show that up to now nowhere a basic and scientific research has been done to recognize those factors affecting auditors' decisions and judgments pertaining to determination of the materiality level in audition of financial statements and to help them to make accurate use of this concept in audition process, particularly in presenting audition comments. In other words, decision-makings related to the determination of the materiality level are only based on auditors' professional judgments and this fact has led to different comments in similar cases.

Though auditors' professional judgments are the final criteria to judge the materiality level and to determine the kind of audition comments, the scope of this authority assignment requires the recognition of factors and variables affecting on the judgments related to the determination of the materiality level and acquisition of some useful directives by asking for comments and studying auditors' real judgments pertaining to determination of the materiality level in audition of financial statements by making use of scientific methods of research. The extent of accordance of such factors, variables and directives must be tested by getting use of statistical methods. Consequently, the results of the research are presented in the form suitable directives to apply a standard materiality while auditing financial statements. Such directives lead to uniformity in auditors' comments in similar conditions and finally will strengthen the auditor's role of accreditation.

Problem Statement:

Materiality is among those concepts that have been mentioned a lot in auditory and accounting literature. The application of the terms like considerable, inconsiderable, material, immaterial and considerable, uncontroversial aren't so important that necessitates any discussion. The application of the terms like vital, material and vital, not vital, significant, too upside-down appearance of the reality, risk and materiality, considerable risk, material deviations, ignorable deviations and etc. verifies the attention which auditory and accounting professions pay to the issue of materiality.

The definition of materiality, as a word, is relatively simple. Nowadays, materiality, as a concept which must be applied in accounting and reports, has been turned into such a significant issue whose precise definition has been very difficult.

In other terms, the assessment criterion of the materiality level is the amount of influence that financial reports have on users' decision-makings. Regarding the limited amount of awareness of information needs of a huge number of users, financial reports and kinds of decisions that the users make and also kinds of information that can influence their decisions have made it difficult to determine a qualitative indicator for precisely calculation of the materiality level. Up to now, no professional standards have been established to unify or create a unified manner to be used by professional members in determination of materiality level in accounting and auditory and some professional institutions have just provided too limited general directives which are also based on individuals' professional judgments.

The so-called comment reveals the complexities and scope of materiality concept. However, in accounting and auditory literature, in addition to indicating different phases of the process due to judgment, measurement and assessment of the materiality level, a few related directives have also been presented. Based on auditory standards, the auditor must assess the materiality and its relation with audit risk. Auditors are involved in judgments and decision-makings related to materiality in all auditory phases. According to previous research, auditors, in all judgments pertaining to determination of the materiality level, take two groups of factors into accounts:

1. Determinant factors (quantitative factors): some factors as the size of the item to be judged, sum of assets, sum of incomes, average sums of assets and incomes, amount of net profit, amounts of equities, the main capital and the main classes dependent on the being judged item in financial statements are the most important qualitative factors in determination of the materiality level of the auditory.

2. Adjusting factors(qualitative factors): these are factors like inclusiveness of erroneous effects on various parts of financial statements, the relation of the item being judged with dependent and possible personal transactions, nature (intentional or unintentional), being usual or unusual, being estimation-based or specification-based, deviations from legal requirements and audit risk of the item being judged. Such factors may lead to adjust the materiality level in auditory. Some examples of qualitative deviations and errors include unexpressive or inaccurate description of one of accounting procedure (in the case that the users of financial reports become devious because of such erroneous description) and not revealing the reality and reversing legal rules (in the case that its limiting effects influence the operations of the entity being investigated).

Various quantitative procedures, which are helpful in making decisions, can be used to help the auditors to form their judgments about materiality. For example, the method of determining the level of materiality which is the suggested method by Iran Auditory Organization is as follows: X = (sum of assets in balance sheet + sum of sales(incomes))/2 Then the calculated amount of X is entered the following table and the amount of materiality level, which is termed M, is acquired.

Calculation of the materiality level:

Based on million
X amount (million rials)               by           Product

Up to 1000 million                     %3           %3 x 1.000
From 1000 million to 10000 million     %2.5         %2.5x 9000
(that is more than the first
1000 million)

From 10000 million to 100000 million   %2           %2x 90000
(that is more than the first 10000

From 100000 million to 200000          %1.5         %1.5x 100000
million (that is more than the first
100000 million)

More than 200000 million (than is      %1           %1x the extra
more than the first 200000 million)                 amount

The materiality level (M)                           Sum of product

As it can be observed, in the suggested formula only two numbers of quantitative items of financial statements are used. But auditors, in addition to applying more quantitative items, pay attention to various qualitative items, too. At the end of auditory process, as the auditor wants to make decision about materiality, s/he may make different judgments about different items or classification of reciprocal items (which have influence on incomes). For example, an auditor may decide to assign a relatively low level of materiality for that of recording or revealing an event like product summon having lots of negative effect on decisions and judgments made by customers or auditory institution. An auditor may assign a relatively high level of materiality for decisions made about recording or revealing events like dossier recording or penal claims having a little possibility to happen. In this regard, the influence of the subject being judged on net profit, profitability position, cash amount, ability to repay the debts, expectations and predictions of financial analysts and users of financial statements are other qualitative factors which must be regarded. The qualitative factor of inclusiveness of the effects of errors and deviations on different sections of financial statements, in auditing managers' view, is also assumed as an important factor to determine commenting borders, because this factor includes totality of financial statements.

The variables affecting on determination of the materiality level of each item of the items included in financial statements are classified into two groups of quantitative and qualitative variables. Both groups are examined in this study. According to previous studies, comments of standardizing institutions, professional auditory and accounting authorities and experts of the field, the most important variables are as follows:

1. Sum of current assets

2. Sum of long-term assets

3. Average sum of assets and incomes

4. Sum of debts

5. Sum equities

6. Sum of incomes

As it was mentioned, auditors are involved in decision-makings and judgments pertaining to materiality in all auditory phases. Up to now, no clear and precise directives have been made to help the auditors to identify factors affecting on judgments related to determination of the materiality level and monotonous application of qualitative directives. Such fact can lead to auditors' different judgments and comments in quite similar conditions. So, the following deficiencies are resulted:

1. The difference in volume and nature of collected auditory evidence and consequently influencing the efficiency or cost of auditory

2. The difference in kinds of auditors' comments presented in auditory reports about financial statements and consequently influencing auditory efficiency because of resulting in different comments in similar cases and finally questioning the accreditation of auditory in views of the users using auditory services.

3. Being confronted with some problems while changing or substituting auditors in similar comments or annually.

4. Possible wasting of capital of investors, creditors and other beneficiary, rightful and interested individuals because of auditors' different judgments covered in auditory reports.

5. The decrease of comparability of auditory reports in companies having quite similar conditions and issues.

Regarding the above-mentioned issues and the facts that, in fact, a few of above-mentioned quantitative factors have been used to determine the materiality level in all previously-used and present-day methods and qualitative factors have been dependent on auditors' specialized judgments, while judgments related to qualitative factors can be varied from an auditor to another because of their various knowledge and qualifications, it seems necessary to acquire a model which can include acceptable coverage of qualitative and quantitative factors affecting the determination of the materiality level.

Research Methodology:

This section briefly addresses the methodology and results of this scientific research on "determining the audit materiality level using a multiple linear regression-based model in companies listed on the Stock Exchange."

Formation of the research questions and hypotheses:

Literature review suggests that there is a correlation between quantitative (determinant) and qualitative (moderator) factors in determining materiality and the use of different quantitative guidelines related to materiality among auditors at international level. So far, no basic scientific research has been done for determining factors affecting the judgment associated with materiality level in auditing financial statements from the perspective of Iranian auditors which presents comprehensive guidelines on this subject. Obviously, the absence of such guide lines leads to inconsistency and lack of uniformity in auditing statements, problems when changing auditors, changes in the volume of reviews, and lower efficiency and effectiveness of auditing.

The main objective of this study is to determine materiality with high accuracy and present a new formula using a multiple linear regression-based model for determining materiality in the preliminary planning stage.

This research seeks to answer the following questions:

Can one develop a quantitative model based on multiple linear regression to determine the quantitative materiality amount using the main factors influencing materiality?

Are the efficiency and accuracy of our model higher than those the Audit Organization's model?

Is the error of our model different in different industries listed on the Stock Exchange?

According to the research questions, the following hypotheses were developed:

First hypothesis: It is possible to determine the audit materiality level using a multiple linear regression model based on variables (total assets, total revenues, net income and equity).

Second hypothesis: There is a significant difference between the error of our model and that of the Audit Organization's model for determining materiality.

Third hypothesis: There is a significant difference between the errors of our model for determining materiality in different industries.

Research implementation stages:

Information required for this research was collected through two tools: written questionnaire (survey) and objective observation (document study.) First, through desk studies and previous research, factors affecting judgments for determining materiality in auditing and their relative materiality were identified and then four key factors influencing materiality (total assets, total revenues, net income, and equity) were selected for designing the model.

The statistical population included 210 series of financial statements for 30 companies listed on the Tehran Stock Exchange for seven consecutive years (2004-2010.) At the first stage, information for four independent variables (assets, revenues, net income, and equity) was extracted from financial statements of the desired companies.

In the second stage, the opinions of financial statements auditors of companies in the sample were gathered to extract the quantitative materiality amount in the audit planning stage by sending a written questionnaire for them.

Results of studying the research hypotheses and offering suggestions:

The result of the first hypothesis was a quantitative model based on multiple linear regression for determining materiality. This model was designed based on four variables affecting materiality (assets, revenues, net income, and equity).

Y=1851873017.332+.012T.ASSET-.007T.REVENUE+ [absolute value of .074T.N.INCOME] -.031T.EQUITY

Unlike the formula proposed by the Audit Organization which uses two quantitative factors (assets and revenues) for determining materiality, our model uses four quantitative factors.

To test the second hypothesis, the error of our model was compared with that of the Audit Organization's model. Based on the results obtained from testing the second hypothesis, the mean error of our model is lower than that of the Audit Organization's model which demonstrates the accuracy and efficiency of our model.

The third hypothesis seeks to compare the mean error of the model in different industries. To this end, various industries in the research sample were classified and then the mean error for different industries were compared and tested. The test results show that there is a significant difference in various industries in the model error.

Given that the overall result derived from the research is to develop a model to determine materiality in auditing, the audience of the research suggestions is auditors and the Audit Organizations.

1. The authorities of developing auditing standards are recommended to consider the results of the present study in developing auditing standards for financial statements.

2. Appropriate and continuous training of auditors for correct application of the developed standards and its effect on boosting their exploration morale for improving the effectiveness of the audit process.

3. Iranian auditors seldom use the materiality concept in the auditing planning stage. If they use it, they do not document it in the audit worksheets (audit plan). In other words, auditors use the materiality concept mainly in the final evaluation stage when determining the type of audit opinion. One of the important applications in the planning and testing stage is to set the sample size. Since item selection for auditing is mostly subjective and based on key items, and statistical sampling is rarely used, so the materiality application has decreased in the audit planning stage in Iran. Another suggestion of this research is to document the materiality amount in the planning stage in audit worksheets or financial statements notes.

4. In materiality judgments, one must pay attention to the nature of items and qualitative factors. Moreover, one must consider the effects of mistakes and distortions first individually and then totally for financial statements.

5. According to the result obtained from testing the second hypothesis, our model is more accurate and has less error than the formula proposed by the Audit Organization. So, the Audit Organization can improve its guidelines about materiality and encourage auditors to use them better.

6. According to the results obtained from testing the third hypothesis, there is a significant difference in the research model error in various industries. So, the Audit Organization and auditors are recommended to use a model suitable for each industry for determining materiality.

Suggestions for future research:

1. Determining materiality in the audit planning stage can be different from the final evaluation stage. In this regard, it is necessary to explore setting materiality, especially in the planning stage.

2. A series of research based on the use of more quantitative factors can be investigated in determining materiality.

3. To develop guidelines for determining materiality, some studies can be done which include qualitative factors in addition to quantitative factors.


Article history:

Received 15 April 2014

Received in revised form 22 May


Accepted 25 May 2014

Available online 15 June 2014


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(1) Yaser Abbasabadi, (2) Azar babaye azar, (3) Fazlolah Saadat, (4) Maryam koohkan, (5) Somayeh sarooee, (6) Behzad sooki

(1) Department of Accounting, kangavar Branch, Islamic Azad University, kangavar, Iran.

(2) Department of Accounting, kangavar Branch, Islamic Azad University, kangavar, Iran.

(3) Department of Accounting, kangavar Branch, Islamic Azad University, kangavar, Iran.

(4) Department of computer Engineering, Malayer Branch, Islamic Azad University, Malayer, Iran.

(5) Department of Accounting, kangavar Branch, Islamic Azad University, kangavar, Iran.

(6) Department of Management, kangavar Branch, Islamic Azad University, kangavar, Iran.

Corresponding Author: Yaser Abbasabadi, Department of Accounting, kangavar Branch, Islamic Azad University, kangavar, Iran. E-mail:
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Author:Abbasabadi, Yaser; azar, Azar babaye; Saadat, Fazlolah; koohkan, Maryam; sarooee, Somayeh; sooki, Be
Publication:Advances in Environmental Biology
Article Type:Report
Date:Jun 1, 2014
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