Final answer:
When net income is fluctuating, an auditor should consider basing materiality on average earnings from multiple periods to achieve a more stable and representative base for materiality levels.
Step-by-step explanation:
When net income is fluctuating, the auditor should consider basing materiality on average earnings. Fluctuations in net income can result from various factors, including irregularities in the object being measured or other situational factors. Since these can affect audit conclusions, auditors seek a broader and more consistent base for assessing materiality.
Rather than focusing on a single period's net income, which may not be representative, using average earnings from multiple periods can provide a more reliable indicator for setting materiality thresholds. This approach smooths out the effects of irregularities and provides a clearer picture of the entity's financial performance.
In practice, auditors might take an average of several years' net income or look for normalized earnings by adjusting for one-time gains or losses. Selecting a suitable period to average also requires professional judgment, depending on industry practices, the entity's circumstances, and economic conditions. By applying such careful consideration, auditors can set a materiality level that is aligned with users' financial decision needs.