Materiality under SA 320, Materiality in Planning and Performing an Audit is a matter of professional judgment, not a percentage copied from last year's file. The standard applies to audits of financial statements for periods beginning on or after 1 April 2010. Its starting point is paragraph 2: misstatements, including omissions, "are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements." A misstatement can be material because of its size, its nature, or both.
This guide covers what SA 320 requires, how benchmarks and percentages are chosen, why performance materiality sits below overall materiality, how SA 450 treats the misstatements you find, and what a reviewer expects to see in the working papers. The figures in the worked examples are illustrative.
Who the "users" are
SA 320 paragraph 4 lets the auditor assume that users have reasonable knowledge of business and accounting, study the financial statements with reasonable diligence, understand that financial statements are prepared and audited to levels of materiality, recognise the uncertainty in estimates and judgment, and make reasonable economic decisions. Materiality is set for the common information needs of users as a group, not for one lender's covenant or one shareholder's special interest.
The four requirements in SA 320
| Paragraph | Requirement |
|---|---|
| 10 | Determine materiality for the financial statements as a whole when establishing the overall audit strategy, and, where relevant, lower materiality levels for particular classes of transactions, account balances or disclosures. |
| 11 | Determine performance materiality "for purposes of assessing the risks of material misstatement and determining the nature, timing and extent of further audit procedures". |
| 12 to 13 | Revise materiality if information comes to light during the audit that would have "caused the auditor to have determined a different amount initially"; if it is lowered, reconsider performance materiality and further procedures. |
| 14 | Document the amounts and the "factors considered in their determination", and any revision. |
Overall, specific and performance materiality
Materiality for the financial statements as a whole
This is the level above which misstatements, alone or together, could influence users' decisions. It frames the opinion.
Specific materiality
Some items attract user attention out of proportion to their size: related party transactions, directors' remuneration, a disclosure a regulator watches, or a key segment. Paragraphs A10 to A11 point to law or regulation, industry-specific disclosures and the aspects of the business users focus on as indicators that a lower level is needed for a particular class, balance or disclosure. Discussion with those charged with governance helps identify them.
Performance materiality
Paragraph 9 defines it as "the amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality." The reason is aggregation risk: if every test were designed only to catch items above overall materiality, many smaller errors could slip through and together cross the line. Paragraph A12 says setting it is not a mechanical calculation; it depends on the auditor's understanding of the entity, updated during risk assessment, and on the nature and extent of misstatements found in previous audits. A client with a history of adjustments and weak controls needs a lower figure than a clean, stable one.
Choosing a benchmark
Paragraph A3 lists examples of benchmarks: categories of reported income such as profit before tax, total revenue, gross profit and total expenses, total equity or net asset value. The choice depends on what users of this entity focus on. Factors include the elements of the financial statements, the entity's nature and life-cycle stage, its industry and economic environment, its ownership and financing structure, and the relative volatility of the benchmark.
Paragraph A4 says the relevant financial data ordinarily includes prior periods' results and financial position, period-to-date figures, and budgets or forecasts for the current period, adjusted for significant changes in circumstances. Paragraph A5 adds that where the reporting period is longer or shorter than twelve months, materiality relates to the financial statements for that period.
| Entity | Benchmark users are likely to focus on |
|---|---|
| Stable profit-making manufacturer | Profit before tax from continuing operations |
| Owner-managed company paying out most profit as remuneration | Profit before remuneration and tax (A7) |
| Not-for-profit entity | Total revenue or total expenses |
| Investment or asset-holding entity | Total equity or net asset value |
| Loss-making or break-even company | Revenue, gross profit or total expenses, rather than a near-zero profit figure |
Choosing the percentage
SA 320 does not prescribe a mandatory percentage. Paragraph A6 explains that "there is a relationship between the percentage and the chosen benchmark, such that a percentage applied to profit before tax from continuing operations will normally be higher than a percentage applied to total revenue." It gives two examples: five percent of profit before tax from continuing operations may be appropriate for a profit-oriented entity in a manufacturing industry, and one percent of total revenue or total expenses may be appropriate for a not-for-profit entity. Firm methodologies often give starting ranges; the file still needs engagement-specific reasoning for the figure chosen.
Worked example 1: setting the three levels
A manufacturing company's forecast profit before tax from continuing operations is ₹4.20 crore. The engagement partner selects PBT as the benchmark and applies 5%, following the A6 example.
- Overall materiality: 5% of ₹4,20,00,000 = ₹21,00,000.
- Performance materiality: the firm's methodology, applied to a client with few prior-year adjustments, sets it at 75% of overall materiality = ₹15,75,000. A client with weaker controls or several past adjustments would justify a lower proportion.
- Threshold for clearly trivial items: the team sets 5% of overall materiality = ₹1,05,000. Items below this are not accumulated.
- Specific materiality: related party transactions and key managerial personnel remuneration are tested to a lower level because users read those disclosures closely whatever their size.
The 75% and 5% proportions are firm methodology choices for this illustration, not SA 320 requirements. What SA 320 requires is that each figure and the reasons for it are documented.
Worked example 2: an owner-managed company
A private company run by two shareholder-directors reports PBT of ₹8,00,000 after paying them ₹60,00,000 as remuneration. Five percent of reported PBT gives materiality of only ₹40,000, which would drive testing far beyond what users of this company need. Paragraph A7 recognises that where the owner takes much of the profit as remuneration, profit before remuneration and tax may be more relevant. Five percent of ₹68,00,000 gives ₹3,40,000. The file should record why this benchmark reflects the users' focus.
Worked example 3: a not-for-profit trust
A charitable trust spends ₹12 crore a year on its programmes and has no profit measure. Applying the A6 example of 1% of total expenses gives overall materiality of ₹12,00,000. Grants received under donor conditions may call for specific materiality lower than this.
Revising materiality: example 1 continued
Planning used forecast PBT of ₹4.20 crore. Actual PBT comes in at ₹2.80 crore after a large order is cancelled. Paragraph A13 lists actual results that differ substantially from the anticipated period-end results as a reason for revision. Recomputed at 5%, overall materiality falls to ₹14,00,000 and performance materiality at 75% to ₹10,50,000.
The team had accumulated five uncorrected misstatements of ₹6,50,000, ₹4,80,000, ₹2,90,000, ₹1,20,000 and ₹80,000, a total of ₹16,20,000. Against the original ₹21,00,000 they looked immaterial; against the revised ₹14,00,000 they exceed materiality in aggregate. Unless management corrects enough of them, the opinion is affected. Because materiality was lowered, paragraph 13 also requires the team to consider whether performance materiality and the nature, timing and extent of further procedures are still appropriate, which here means extending some tests.
Where SA 450 takes over
SA 450, Evaluation of Misstatements Identified during the Audit, governs what happens to the misstatements found.
- Accumulate: "The auditor shall accumulate misstatements identified during the audit, other than those that are clearly trivial" (paragraph 5). SA 450 separates factual misstatements (no doubt), judgmental misstatements (unreasonable estimates or policy choices) and projected misstatements (extrapolated from sample results).
- Revisit the plan when the nature of misstatements suggests others may exist, or when the aggregate of accumulated misstatements approaches materiality (paragraph 6).
- Communicate and ask for correction: all accumulated misstatements go to the appropriate level of management on a timely basis, with a request to correct them (paragraph 8).
- Reassess materiality under SA 320 before evaluating what is left uncorrected, to confirm it remains appropriate in light of actual results (paragraph 10).
- Evaluate whether uncorrected misstatements are material individually or in aggregate, considering size, nature and circumstances (paragraph 11).
- Tell those charged with governance about uncorrected misstatements and their possible effect on the opinion (paragraph 12).
- Obtain a written representation that management believes the effects of uncorrected misstatements are immaterial to the financial statements as a whole (paragraph 14).
Small amounts can still be material
SA 320 paragraph 6 makes clear that materiality set at planning does not establish an amount below which uncorrected misstatements will always be judged immaterial. The circumstances of some misstatements can make them material even when they fall below the numerical threshold. Examples in practice include an error that turns a small profit into a loss, an item that affects compliance with a loan covenant or regulatory requirement, a misstatement that hides a change in earnings trend, and anything involving fraud or an illegal act. Record the qualitative reasoning, not just the number.
What the working papers should show
- Who the users are and what they focus on, and why the chosen benchmark reflects that.
- The benchmark figure, its source (prior year, period-to-date, budget) and any normalisation for one-off items.
- The percentage and the engagement-specific reason for it.
- Performance materiality and the factors behind it: control environment, prior misstatements, expected errors.
- Any specific materiality levels and the items they cover.
- The clearly trivial threshold used for accumulating misstatements.
- Each revision, the trigger and the effect on procedures (paragraph 14).
- The SA 450 summary of corrected and uncorrected misstatements, the governance communication and the written representation.
Mistakes reviewers flag
- 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.
- Dropping several smaller misstatements because each is below overall materiality.
- Not revisiting materiality when actual results are far from the planning figures.
- Recording the final number without the judgment that supports it.
Updated on 27 September 2026: retitled, added SA 320 paragraph references, the A6 benchmark examples, three worked materiality calculations including a revision that changes the outcome, and the SA 450 steps with paragraph numbers.
