Audit Materiality
SA-320 (Revised)
Presented by
Sanjay Vasudeva, Partner
S.C. Vasudeva & Co.
Chartered Accountants
.
.
Scope
Objective
Definitions
Materiality in context of an Audit
Requirements
•Determining Materiality & Performance Materiality
•Revision of Materiality
•Documentation
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SA 320 deals with the auditor’s responsibility to apply the
concept of materiality in planning and performing an audit of
financial statements.
Objective
The objective of the auditor is to apply the concept of materiality
appropriately in planning and performing the audit.
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Performance materiality means 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 for the financial statements as a whole
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Financial Reporting Framework
 Financial reporting frameworks normally discuss “materiality”
in context of preparation & presentation of financial
statements:Misstatements are material if in aggregate /individually may
influence economic decision of users of financial statements.
Judgments on materiality made in light of surrounding
circumstances and are affected by the size or nature of a
misstatement or a combination of both, and
Judgments about matters that are material to users of the
financial statements are based on a consideration of the
common financial information needs of users as a group.
Contd..
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Concept of Materiality


Concept of materiality in context of audit according to “Guidance
note on accrual basis of accounting issued by ICAI”The aspects of materiality is a vital factor as to nature & extent of
audit coverage required in conducting an audit that is framing of
audit programe with keeping in mind materiality
a) As per AS-1 “ Disclosure of Accounting Policies”
“Financial Statements should disclose all “material” items i.e items
the knowledge of which might influence the decisions of the users
of the financial statements”
b) Concept of “True & Fair” also recognizes that the concept of
materiality must be given due importance in the preparation and
presentation of financial statements
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Concept of Materiality
c) Guidance Note on accrual basis of accounting issued by ICAI
provides concept of materiality in the context of an Audit as follows:
The aspects of materiality is vital factor as to the nature and extent of audit
coverage required in conducting of an audit i.e. the question of materiality has a
direct bearing in shaping an audit programme aiming to conduct an audit
effectively.
d) Materiality Concepts as per RBI Guidelines based on N.D. Gupta
Committee
“In his approach to audit the auditor should keep in mind the concept of
‘materiality’. Items that do not materially affect the views presented by the
financial statements may be ignored. In case of some banks, Head Office
circular indicates the quantum of materiality to be considered by the branch
auditor. The concept of materiality is fundamental to the reporting of
information. Materiality depends on the size, nature and circumstances. Hence,
the branch auditor has to decide on the materiality taking into account the
amount involved and the impact of the financial statement. If there is a basic
mistake in the accounting principle, then such transaction may be reported
through Memorandum of Changes even if the amount involved is not material.
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Materiality in the context of Financial
Reporting Framework
Revised
Schedule
VI
• Disclosure for items of income
and expenditure which exceeds
1%
of
revenue
from
operations or Rs 100,000
whichever is higher.
Old
Schedule
VI
• Disclosure
for
items
of
expenditure which exceeds 1% of
total revenue or Rs 5,000
whichever is higher.
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
The auditor’s determination of materiality is a matter of
professional judgment, and is affected by the auditor’s
perception of the financial information needs of users of the
financial statements. In this context the auditor assumes that
users :
 Have a reasonable knowledge of business and economic activities and
accounting and a willingness to study the information in the financial
statements with reasonable diligence;
 Recognize the uncertainties inherent in the measurement of amounts
based on the use of estimates;
 Understand that financial statements are prepared, presented and
audited to levels of materiality; and
 Make reasonable economic decisions on the basis of the information in
the financial statements.
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Illustrative Factors for Consideration of Materiality:
Factors for consideration
Illustration
Materiality to users is based on
common financial need of users of
group and thus possible effect of
misstatement
on
specified
individual user whose need may
vary widely need not be
considered,
Paragraph 10 of the “Framework
for
the
Preparation
and
Presentation
of
Financial
Statements,” issued by ICAI in
July 2000, indicates for a profit
oriented entity that “as provides of
risk capital to the enterprise,
investor need more comprehensive
information than other users. The
provision of financial statements
that meet their needs will also meet
most of the needs of other users
that financial statements can
satisfy”.
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Illustrative Factors for Consideration of Materiality:
Factors for consideration
Illustration
Apart from the size (or magnitude) of
an item, its nature is also an important
factor in determining whether or not it
is material in the facts and
circumstances of a case
If the discovery of an illegal payment,
even of a small amount could result in
the closure of an enterprise, the item is
material.
Similarly, inadequate or
improper description of an accounting
policy would be material if it is likely
to mislead the users of the financial
statements.
An item of information is material, if
its omission or misstatement can
influence the economic decisions of the
users of the information.
If fake sales of significant amounts are
recorded in the books of account of a
company, it would result in overstatement of sales and profit as shown
by the financial statements. A potential
investor may be induced by the figure
of profit shown in the financial
statements to invest in the shares of the
company.
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Illustrative Factors for Consideration of Materiality:
Factors for consideration
Illustration
What is material depends upon the For example, omission of sale invoice
particular facts and circumstances of of Rs. 10000/- in an enterprise with
each case.
turnover of say Rs. 1000/- crores, may
not normally be material. However,
the omission could become material if
the turnover of the enterprise were say
Rs. 5 lacs.
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Materiality and Audit Risk
 The concept of materiality is applied by the auditor both in planning and
performing the audit, and in evaluating the effect of identified
misstatements on the audit and of uncorrected misstatements, if any, on the
financial statements and in forming the opinion in the auditor’s report.
 In conducting an audit of FS, the overall objectives of the auditor are to
obtain reasonable assurance about whether the financial statements are as
a whole free from material misstatement , whether due to fraud or error,
thereby enabling the auditor to express an opinion.
 Materiality & risk are considered throughout the audit, in particular,
when:
 Identifying and assessing the risks of material misstatement ;
 Determining the nature, timing and extent of further audit procedures; and
 Evaluating the effect of uncorrected misstatements, if any, on the financial
statements and in forming the opinion in the auditor’s report.
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
The materiality determined when planning the audit does not
necessarily establish an amount below which uncorrected
misstatements, individually or in aggregate, will always be
evaluated as immaterial. The circumstances related to some
misstatements may cause the auditor to evaluate them as
material even if they are below materiality. The auditor
considers not only the size but also the nature of uncorrected
misstatements , and the particular circumstances of their
occurrence , when evaluating their effect on the financial
statements
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Determining Materiality and Performance Materiality when
Planning the Audit
 When establishing the overall audit strategy ,the auditor shall
determine materiality for the financial statements as a whole
and if, in the specific circumstances of the entity, there is one
or more particular classes of transactions, account balances or
disclosures for which misstatements of lesser amounts than the
materiality for the financial statements as a whole could
reasonably be expected to influence the economic decisions of
users taken on the basis of the financial statements, the auditor
shall also determine the materiality level or levels to be
applied to those particular classes of transactions, account
balances or disclosures .
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Determining Materiality and Performance Materiality when
Planning the Audit
Use of benchmarks in determining materiality for financial
statements as a whole
 Determining materiality involves the exercise of professional
judgment. A percentage is often applied to a chosen
benchmark as a starting point in determining materiality for
the financial statements as a whole. Factors that may affect
the identification of an appropriate benchmark include the
following:
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Determining Materiality and Performance Materiality when
Planning the Audit
Use of benchmarks in determining materiality for financial
statements as a whole
 The elements of the financial statements (for example, assets,
liabilities, equity, revenue, expenses);
 The nature of the entity, where the entity is at in its life cycle,
and the industry and economic environment in which the entity
operates;
 The entity’s ownership structure and the way it is financed and
 Whether there are items on which the attention of the users of
the particular entity’s financial statements tends to be focused
(for example, for the purpose of evaluating financial
performance users may tend to focus on profit, revenue or net
assets);
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Determining Materiality and Performance Materiality when
Planning the Audit
Use of benchmarks in determining materiality for financial
statements as a whole
Consideration specific to small entities
 Where entity’s profit before tax from continuing operations is
consistently nominal and owner takes much of PBT in the form
of remuneration then relevant benchmark may be=Profit
before remuneration.
 In the case of certain entities, such as, Central/State
governments and related government entities (for example,
agencies, boards, commissions) regulators are often primary
users therefore the benchmark would be influenced by
Legislative & Regulatory requirements
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Computation of Materiality
For other than not
for profit making
entity
i) For a company having
consistent
pattern of profit
5% of profit before tax
ii) For a company having
business losses
1% of Gross turnover
iii) In other case
0.25% - 1.5% of Gross
Fixed Assets /Capital Work
in Progress
For Not for Profit
making entity
1% of Total
Income or
1% of Total
Expenditure
Whichever is
lower.
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Materiality Levels –Levels of particular class of transactions
 Factors that may indicate the existence of one or more particular
transactions ,account balances or disclosures for which
misstatements of lesser amounts than materiality for the financial
statements would affect the economic decisions of users-:
 Whether law, regulations or other applicable financial reporting framework
affect users expectations regarding the measurement or disclosure of certain
items (eg. Related Party Transactions- For example - remuneration of
management and those charged with governance ).
 The key disclosures in relation to the industry in which the entity
operates(eg. research and development costs for a pharmaceutical company)
 Whether attention is focussed on a particular aspect of the entity’s business
that is separately disclosed in the FS(eg. A newly acquired business)
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


Is the amount set at less than materiality to reduce to an
appropriately low level the probability that the aggregate of
uncorrected and undetected misstatements exceeds materiality.
The auditor shall determine performance materiality for purposes of
assessing the risks of material misstatement and determining the
nature, timing and extent of further audit procedures
Planning the audit solely to detect individually material
misstatements overlooks the fact that the aggregate of individually
immaterial misstatements may cause the FS to ne materially
misstated and leaves no margin for possible undetected
misstatements
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
The determination of performance materiality is not a simple
mechanical calculation and involves the exercise of
professional judgment. It is affected by issues such as:
 The auditor’s understanding of the entity;
 Experience in the prior year audits;
 nature and extent of misstatements identified in prior year audits;
 auditor’s expectations in the current year;
 the risk assessment.
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Example 1: Materiality for entity A has been set at
Rs.50,00,000 for current period audit and the
engagement team is about to determine performance
materiality . Entity is an IT Consulting Firm and there
have been no significant changes in the entity’s
business, internal control, risk of material
misstatements or management . The Entity has been a
client for 5 Years and the uncorrected misstatements
have been in region of 20%-30% of materiality. Last
Uncorrected misstatements are 10,34,280/-.
What would you, as auditor of the entity fix as the
performance materiality?
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Example 2: For entity “A ” materiality has been
set at Rs. 50,00,000 again, the uncorrected
misstatements in the previous audit
were
1,243,257 .There have been no significant
changes in entity’s business, internal control or
risk of material misstatements but the entity has
partly new management starting a few months
into the current period .
What would you, as auditor of the entity fix as
the performance materiality?
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Example 3:Materiality for Entity ‘B’ has been set for Rs
900,000 for the current period audit. Entity ‘B’ is an importer
of fine Italian wine and food and has been audit client for 2
years . There have been no significant changes in the entity’ s
business , internal control , risks of material misstatement or
management .Last audit’s uncorrected misstatement
amounted to Rs 421,853 with two of the misstatements
carrying over and reversing in the current period to an
amount of Rs 171,853. The engagement team’s best estimate
of the current period’s uncorrected misstatements is to be
similar to the prior period .
What would you, as auditor of the entity fix as the
performance materiality?
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Example 4: A student took an admission in an
auditing course. Course contains 60 lectures in
total. In order to qualify for exam entrance,
students have to fulfill attendance criteria i.e.
student can be absent from 10 lectures as a
whole but not more than 1 lecture in a week.
What is the minimum number of lectures he
needs to attend in a year? What does the second
level of restriction imply?
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Answer


The aforesaid attendance policy has two levels of restrictions. First that
students cannot leave more than 10 lectures unattended during the whole
course. Whereas, the second level is that maximum of one lecture can be
left unattended in a particular week. This second restriction is probably
there to ensure that no student miss 10 lectures in a row.
A similar concept is true in auditing. Performance materiality (materiality
established for a particular component inside financial statement for
example an assertion level) i.e. materiality established while performing
audit procedures on certain account balances and/or transactions etc is
deliberately set lower than the materiality level for the financial statements
as a whole so that overall misstatements are kept under the materiality level
set for the financial statement as a whole.
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The auditor shall revise materiality for the financial statements
as a whole in the event of becoming aware of information
during the audit that would have caused the auditor to have
determined a different amount initially.
 Necessary to re-perform the calculations may be on the basis of
result of change in circumstances that occurred during the audit
 For Example –a decision to dispose of major part of entity’s
business or if the actual financial results are likely to be
substantially different from anticipated results ,new
information, or a change in the auditor’s understanding of
the entity and its operations as a result of performing further
audit procedures
.

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
The audit documentation shall include the following amounts
and the factors considered in their determination:
 Materiality for the financial statements as a whole;
 If applicable, the materiality level or levels for particular classes of
transactions, account balances or disclosures;
 Performance materiality, and
 Any revision of the above as the audit progressed.
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THANK YOU
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