What Materiality Represents In Terms Of The Audit Of A Set Of Financial Statements?

The Level of Materiality to Be Used For the Audit

Meridian Energy Group Limited is among the largest organizations in New Zealand. It earns a revenue of $2,762 million in the financial year 2018 and realizes net assets amounting to $4,823 million. This paper is primarily purposed to examine the 2017 annual report for Meridian Energy Group Limited and determine the level of materiality that should be used for the group accounts for the fiscal year ending 2017. This report also represents a preliminary analytical review on the information that is provided by the company. Key balance sheet and profit and loss ratios over the period 2014 to 2017 have been addressed. Additionally, the report gives a review of the cash flow statement of the company and discusses its primary cash receipts and cash payments during the year ending 2018 (Meridian Energy Group, 2018).

Nature of Materiality

According to International Standards on Auditing (ISA) 320, materiality refers to misstatements or omissions of key financial items that are considered significant either individually or collectively, in influencing the financial and economic decisions of various users of financial statements presented by an entity. However, the nature and magnitude of materiality is highly dependent on the size of the reporting company or entity, the nature and size of the financial item. (Reding, & Institute of Internal Auditors Research Foundation. IIARF, 2013). In Meridian Energy Group Limited, determination of the level of materiality to be used in the audit is very important (Media, 2012).

Materiality in the audit of financial statements represents significant errors or misstatements in the amounts reported. Misstatements or errors in financial statements are often considered as misstatements that have not been recorded or corrected. In normal financial statement audits, auditors often consider identifying and reporting the dollar amount of such errors and misstatements on a schedule which normally provides a listing of two main categories of errors in financial reports (Reding & Institute of Internal Auditors Research Foundation, 2013). These include:

Amounts reported in financial statements which have been recorded incorrectly. These are transactions which were generally not recorded correctly since they were posted in incorrect amounts or in wrong accounts.
Amounts that should have been recorded in the financial statements but were not (Moeller, 2016).

The auditor is responsible for calculating and determining the exact dollar amount of the financial statement misstatements and errors that are considered to have been unrecorded or uncorrected in such reports. For errors that are based on an adjustment which is based on estimates, the auditor must consider them to have been caused by deficiencies or weaknesses in the internal controls of Meridian Energy Group Limited. Therefore, the auditor must make a consideration to review each and every financial statement item against an acceptable level of materiality which is determined prior to the audit, with an aim to determine whether adjustments should be made to financial statements or not Liu, 2015).

Different Bases and Considerations Employed in Arriving at Materiality

The Rationale behind Your Choice of a Certain Level of Materiality

In determining the levels of materiality for Meridian Energy Group Limited, the auditor must consider various bases and factors. For example, the materiality level used should relate to the various uses and purposes intended for the audit of the company’s financial statements audit. Therefore, it is essential for the auditor to understand the financial information which is considered important and useful to decision makers and users of such reports (VALLABHANENI, 2018). For example, with respect to issues relating to solvency or regulation, the materiality level is highly dependent on the benchmarks in solvency ratios derived from the industry in which the group company operates. In addition to this, for appraisal purposes, the materiality level is specifically determined by the net income or net worth of the company, as well as it’s per share earnings. Furthermore, for general purposes which are related to financial statements of the company, the materiality level is highly dependent on the net surplus and the net capital or net income of the company as well (Meridian Energy Group, 2018).

The level of materiality is also influenced by other features or characteristics of the company which include its size and access to capital, as well as the stage of organizational life cycle. A company’s financial strength is also critical in determination of the level of materiality that should be adopted for the financial audit. It is generally agreed that as an entity approaches a given level of materiality, the materiality standard for work relating to that threshold becomes more rigorous (Meridian Energy Group, 2018).

Determining and ascertaining the dollar amounts that are considered material misstatements and errors in the financial statement is highly influenced by objectivity of the auditor. The auditor usually applies a specific percentage or range of materiality to dollar amounts of each item in the financial statements taken as a whole. This percentage is normally chosen as a benchmark for ascertain the maximum level of materiality beyond which financial statements and reports must not me misstates, since they would significantly influence decision making capabilities of users. These chosen benchmarks are based mainly on financial statement items such as gross profit or total revenues (Meridian Energy Group, 2018).

In determination of the materiality level relating to unrecorded as well as uncorrected misstatements and errors in the financial statements of Meridian Energy Group Limited, the auditor should use the 5% rule. This rule is very essential in providing a general level of materiality that should be adopted in financial statements audits. According to this rule, the value of misstatements in dollar amounts is determined with key consideration to a specified percentage of materiality level which should not exceed this limit (Verschoor, 2008). The auditor must therefore, is therefore a need to take appropriate audit tests and measures for ascertaining whether or not the actual misstatements happened. In the audit of Meridian Energy Group Limited, 5% is therefore considered the maximum level of materiality which must not be exceeded in the financial statements audit. Misstatements which exceed this limit in the financial statements of Meridian Energy Group Limited are thus considered material (Key, Riddle & Institute of Internal Auditors, 2012).

Review the Various Draft Notes and Disclosures

A Preliminary Analytical Review on the Information Provided

After reviewing several draft notes and disclosures that accompany the draft annual report of are thus considered material, various significant issues were observed. For instance, the Hydro inflow is a significant matter in the financial year of the company. The dry conditions that were experienced during the start of the financial year continued to January. However, the conditions changed abruptly in February. This is believed to have caused material and significant changes in the revenues realized by Meridian Energy Group Limited since the weather changes enabled the catchment areas to deliver more water into river Waitaki than in any other time in the previous five years. The company has therefore experienced a good storage of water since the onset of winter. The Meridian Energy Group Limited was however affected significantly by the dry conditions since it was forced to reduce materially its hydro generation production, thus calling of electricity swaptions during the first half of its 2017 financial year (Wells, 2014).

In addition to this, Meridian Energy Group Limited makes a review of its tangible and intangible assets at each balance date. These assets are grouped by the company as per the cash generating units with cash flows that can be identified separately. The recoverable amount is considered as the higher of the fair value of the asset less the selling costs and the resent value of the projected cash flows of the asset. In the financial year 2018, Meridian Energy Group Limited there was a significant impairment in the book value of the central wind consent. This is because development at the particular location of the item was not most likely to happen before the existing resource consent had expired (Jubb, 2010).

Key Balance Sheet and Profit & Loss Ratios

Based on the results obtained from the above ratios as well as the nature of Meridian Energy Group Limited company’s business and its markets, there are apparent trends and changes its key ratios. For instance, the return on shareholders’ equity for the company increased from 3.66% to 3.88% during the year 2016 and 2017 respectively. The Earnings per Share (EPS) also increased by 0.50 cents in the financial years ended 2016 and 2017. Additionally, there was an increase of 1.43% in debt to equity ratio during the year 2016 and 2017. However, the current ratio of the group company dropped by 0.05 n the two years (Hayes, Gortemaker, & Wallage, 2014).

Relevant Assertions and Audit Procedures

In the audit of Meridian Energy Group Limited, it is important for the auditor to make various assertions regarding the classes of transactions and related disclosures for the financial year ending 2018 (Meridian Energy Group, 2018).

Accuracy

The accuracy of the amounts reported in the financial statements of Meridian Energy Group Limited need to be examined by the auditor. This can be accomplished by critically examining the financial records to ascertain that the transactional amounts have been recorded appropriately and necessary disclosures made (Fiedler & Fiedler, 2010).

Completeness

The auditor must ensure that the all events and transactions that took place in the year ending 2017 have been recorded in the financial reports. The auditor can do this through critical examination of the financial records against the original documents (Fiedler & Fiedler, 2010).

Occurrence

It is necessary for the auditor to verify that the recorded events and transactions have actually happened and they pertain to Meridian Energy Group Limited. This can be done by examining and inspecting the original books of accounts such as purchase vouchers (Arens, Elder & Beasley, 2016).

After reviewing the cash flow statement of Meridian Energy Group Limited in the year ended 2018, it has been observed that the majority of the company’s cash inflows were generated from its cash flows from operating activities, totaling to $2,675 million. The company generated net cash flows amounting to $427 million from its operating activities in the year ending 2018. The company’s largest cash outflows were also reported from its operating activities, which totaled to $2,339 million (Meridian Energy Group, 2018). During the year ending 2018, Meridian Energy Group Limited received primary cash receipts of $5,589 million. The company also reported primary cash payments amounting to $3,520 million (Meridian Energy Group, 2018).

According to the cash flow statement of Meridian Energy Group Limited, the company has several non-cash financial and investing activities. For instance, it receives significant amounts from sale of its property, plant and equipment amounting to $23 million. Meridian Energy Group Limited also purchases these items for an amount totaling to $33 million. In addition to this, the group company purchases one of its subsidiaries for $182 million (Crain, Hopwood, Pacini & Young, 2018).

Evaluation of the Going Concern Risk of This Company and Recommended Audit Procedures

According to question 2 and 4, Meridian Energy Group Limited is experiencing key risks in regard to ascertainment of its going concern. For instance, the group company is depends highly on cash inflows from its operating activities because its investing and financing activities reported a negative net cash flows of $224 million and $225 million respectively during the year ended 2018 (Meridian Energy Group, 2018). In addition to this, the greatest cash outflows of the company were reported from its operating activities. This is an indication that Meridian Energy Group Limited makes exceedingly huge payments which may lead to significant stoppage of its operations in future should the cash outflows exceed the inflows. This may highly contradict the going concern of Meridian Energy Group Limited (Aicpa, 2017).

There are several audit procedures that recommended in order to help Meridian Energy Group Limited address these risks. For instance, its management should diversify the operations of the group company in order to ensure that operating activities are not the only main sources of its cash inflows (Meridian Energy Group, 2018). It should also be ensured that the huge costs and expenses are cut or reduced materially. This is very essential in ensuring that the company recognizes an increased amount of free cash flow that can be used for its future expansions in order to guarantee its going concern and eliminating the associated risks (Dennis, 2015).

After reviewing the financial statements of Meridian Energy Group Limited for the year ended 2018, it was observed that the independent auditor issued an unqualified opinion with regard to its consolidated financial statements. In their opinion, it has been certified that the financial statements of Meridian Energy Group Limited are prepared in accordance with the GAAPs. The financial reports of the group company present fairly the financial position of the group as well as its financial performance for the year ended 2018 (Meridian Energy Group, 2018).

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