Audit materiality is not a fixed percentage that can be copied from one engagement to another. Under ICAI's SA 320, Materiality in Planning and Performing an Audit, materiality is a matter of professional judgment. A misstatement can be material because of its size, its nature, or a combination of both, if it could reasonably influence the economic decisions of users of the financial statements.
What audit materiality actually means
Materiality helps the auditor decide what matters enough to affect the audit. It influences planning, the nature and extent of audit procedures, evaluation of identified misstatements and, ultimately, the conclusion on whether the financial statements are free from material misstatement.
The concept is user-focused. The auditor considers the common financial information needs of users as a group rather than trying to design the audit around every possible individual user's special circumstances.
Overall materiality versus performance materiality
Materiality for the financial statements as a whole is the amount or level used to assess whether misstatements, individually or in aggregate, could reasonably influence users' decisions. In some engagements, particular classes of transactions, account balances or disclosures may require a lower specific materiality because smaller misstatements could reasonably influence users.
Performance materiality is deliberately set below overall materiality. SA 320 defines it as an amount or amounts set by the auditor to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. It can also refer to amounts set below specific materiality levels for particular classes, balances or disclosures.
The practical reason is aggregation risk. If the auditor tested only for errors above overall materiality, many smaller errors could remain undetected or uncorrected and together exceed the overall threshold.
How auditors choose an appropriate benchmark
SA 320 explains that determining materiality often involves applying a percentage to a chosen benchmark, but both the benchmark and percentage require professional judgment. Possible benchmarks include profit before tax, total revenue, gross profit, total expenses, total equity or net asset value, depending on the entity and what users are likely to focus on.
Factors relevant to selecting a benchmark include the elements of the financial statements, whether users tend to focus on particular items, the nature and life-cycle stage of the entity, its industry and economic environment, its ownership and financing structure, and the relative volatility of the proposed benchmark.
This means profit before tax may be sensible for a stable profit-oriented business but less useful for an entity with volatile or unusually low profit. A different benchmark may better reflect user focus in a loss-making entity, a not-for-profit organisation, or an asset-focused business.
Why there is no universal materiality percentage
SA 320 does not prescribe one mandatory percentage for all audits. The standard notes that the relationship between the percentage and the benchmark matters and that a percentage applied to profit before tax will normally differ from a percentage applied to revenue. A firm's methodology may provide starting points, but the engagement team still needs to justify the judgment in the circumstances.
Worked illustration
Assume an auditor determines overall materiality of ₹10 lakh for an engagement after considering the appropriate benchmark and engagement circumstances. The auditor would not ordinarily treat ₹10 lakh as the testing threshold for every audit procedure. Performance materiality would be set at a lower amount based on the auditor's assessment of aggregation risk and the likelihood of misstatements.
Suppose several errors below ₹10 lakh are found during testing. Those errors cannot simply be ignored because each is individually below overall materiality. The auditor must accumulate relevant misstatements and evaluate their combined effect under SA 450, Evaluation of Misstatements Identified During the Audit.
What happens when misstatements are identified
SA 450 requires the auditor to accumulate misstatements identified during the audit, other than those that are clearly trivial. The auditor must consider whether the audit strategy and plan need revision if the nature of identified misstatements suggests that other misstatements may exist or if accumulated misstatements approach materiality.
The auditor should communicate accumulated misstatements to the appropriate level of management on a timely basis and request correction, unless prohibited by law or regulation. Before evaluating uncorrected misstatements, the auditor reassesses materiality to confirm whether it remains appropriate in light of the entity's actual financial results.
Quantitative size is not the only consideration
A small amount can still matter because of its nature or circumstances. SA 320 expressly recognises that judgments about materiality are affected by size, nature, or both. Accordingly, the engagement team should not reduce materiality to a spreadsheet formula. Qualitative factors can make a misstatement important even when the amount is below the numerical threshold.
When should materiality be revised?
Materiality is not frozen at planning. SA 320 requires revision if the auditor becomes aware during the audit of information that would have caused a different amount to be determined initially. If overall or specific materiality is revised downward, the auditor must consider whether performance materiality also needs revision and whether the nature, timing and extent of further audit procedures remain appropriate.
Practical documentation checklist
- Identify intended users and their likely focus: document why the selected benchmark reflects the entity's circumstances.
- Record the benchmark and amount: retain the financial data used and explain significant normalisation or adjustment.
- Explain the percentage judgment: do not rely only on a firm template without engagement-specific reasoning.
- Set and document performance materiality: consider prior misstatements, control environment and expectations about current-period errors.
- Consider specific materiality: identify disclosures, balances or transaction classes for which smaller errors could influence users.
- Accumulate identified misstatements: follow SA 450 rather than dismissing every item below overall materiality.
- Reassess before completion: compare planning assumptions with actual financial results and revise materiality where required.
- Document qualitative considerations: record why a quantitatively small matter is or is not material in context.
Common mistakes to avoid
- Using the same benchmark and percentage for every client without considering user focus.
- Treating overall materiality as the minimum size of an item that needs audit attention.
- Ignoring multiple smaller misstatements because each one is below overall materiality.
- Failing to revisit materiality when actual results differ materially from planning figures.
- Documenting only the final number without the professional judgment supporting it.
Practical takeaway
Materiality is a structured professional judgment, not a universal percentage. Overall materiality frames the financial-statement-level assessment; performance materiality is set lower to address aggregation risk; and SA 450 governs how identified and uncorrected misstatements are evaluated. A strong audit file explains the benchmark, judgment, performance materiality, specific materiality where relevant, qualitative factors and any revisions made as the audit progresses. ICAI's current Auditing and Assurance Standards page provides the authoritative standards framework and links to the applicable SAs.
