## Materiality — SA 320
### What Is Materiality?
Misstatements (including omissions) are material if they, individually or in aggregate, could reasonably be expected to influence the economic decisions of users of the financial statements.
Two dimensions determine materiality:
- Size of the misstatement
- Nature of the misstatement (some items are material regardless of amount)
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### SA 320 — Auditor's Responsibility
SA 320 governs the auditor's responsibility to apply materiality in:
1. Planning the audit (determining scope)
2. Performing the audit (evaluating misstatements found)
#### Assumed Profile of Financial Statement Users
The auditor assumes users:
- Have reasonable knowledge of business, economics, and accounting
- Understand that FS are prepared and audited to levels of materiality
- Recognize inherent uncertainties in estimates and judgments
- Make reasonable economic decisions based on FS information
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### Statutory Materiality (Always Material Regardless of Amount)
If disclosure is required by law or regulation, it is always material regardless of value.
Examples under Schedule III, Companies Act 2013:
- Any item of income/expenditure exceeding 1% of revenue from operations OR ₹1,00,000 (whichever is higher) must be disclosed separately
- Shareholders holding more than 5% shares must be specifically disclosed with number of shares held
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### Performance Materiality
Performance materiality = an amount lower than overall materiality set by the auditor to:
- Reduce to an appropriately low level the probability that aggregate uncorrected and undetected misstatements exceed overall materiality
- Provide a buffer so that individually immaterial misstatements do not collectively become material and remain undetected
> Think of it as a safety margin: Overall Materiality > Performance Materiality
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### Benchmarks for Determining Materiality — Mnemonic: VIOLEN
Factors affecting the choice of benchmark:
| Letter | Factor |
|---|---|
| V | Volatility of the benchmark |
| I | Industry and economic environment |
| O | Ownership structure and financing (debt vs equity) |
| L | Life cycle stage of the entity |
| E | Elements of FS (assets, liabilities, equity, revenue, expenses) |
| N | Nature of the entity |
Common Benchmarks by Entity Type:
- Profit-oriented entities → Profit Before Tax (PBT) from continuing operations
- PBT is volatile → Use Gross Profit or Total Revenue instead
- Debt-financed entities → Total Assets or Net Assets (users focus on asset coverage)
Relevant Financial Data for the Benchmark:
- Prior periods' results and financial position
- Period-to-date results
- Budgets/forecasts for the current period
- Adjusted for significant changes (acquisitions, industry shifts)
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### Materiality for Particular Classes of Transactions / Balances / Disclosures
A lower threshold may apply to specific items if misstatements there could influence users even if below overall materiality. Triggers:
1. Legal/regulatory requirements — e.g., related party transactions, management remuneration
2. Key industry disclosures — e.g., R&D costs for a pharma company
3. Specific focus areas — e.g., a newly acquired business disclosed separately
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### Revision of Materiality During the Audit
Materiality may need revision due to:
1. Change in circumstances during the audit (e.g., decision to dispose of a major business segment)
2. New information emerging
3. Revised understanding of the entity after further procedures
4. Actual results differ materially from anticipated results used to set initial materiality
If materiality is revised downward, the auditor must also assess whether:
- Performance materiality needs revision
- Nature, timing, and extent of further procedures remain appropriate
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### Documentation Requirements (SA 320)
The auditor must document:
| What to Document | Detail |
|---|---|
| (a) Overall materiality for the FS | Amount and factors considered |
| (b) Materiality for specific classes/balances/disclosures | If applicable |
| (c) Performance materiality | Amount set |
| (d) Any revision of (a)–(c) | As the audit progressed |
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### Materiality and Audit Risk
Audit Risk = Risk of expressing an inappropriate audit opinion when FS are materially misstated
```
Audit Risk = Risk of Material Misstatement (RMM) × Detection Risk
RMM = Inherent Risk × Control Risk
```
Materiality and Audit Risk are considered together at three key points:
1. Identifying and assessing ROMMS
2. Determining nature, timing, and extent of further audit procedures
3. Evaluating effect of uncorrected misstatements and forming the audit opinion