## SA-320: Materiality in Planning and Performing an Audit
### Concept of Materiality
Misstatements (including omissions) are material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users of the financial statements.
Materiality judgments are affected by:
- Size of the misstatement
- Nature of the misstatement
- Or a combination of both
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### Assumptions About Users
The auditor reasonably assumes that users:
1. Have reasonable knowledge of business, economics, and accounting, and study FS with reasonable diligence
2. Understand that FS are prepared, presented, and audited to levels of materiality
3. Recognize inherent uncertainties in measurement, estimates, and future events
4. Make reasonable economic decisions based on FS information
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### Stages of Materiality
Materiality is applied at three stages:
1. Planning the audit
2. Performing audit procedures
3. Forming the opinion in the auditor's report
At the planning stage, materiality judgments determine:
- NTE of Risk Assessment Procedures
- NTE of Further Audit Procedures
- Identification of RMMs
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### Performance Materiality
> Performance materiality is set lower than overall materiality for the FS as a whole.
Why? Because individually immaterial items may collectively become material when aggregated.
| Aspect | Detail |
|---|---|
| Basis | Professional judgment |
| Effect | Reduces the risk of smaller misstatements going undetected |
| Practical impact | Results in a larger sample size |
| Items above PM but below overall materiality | Auditor performs limited procedures |
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### Relationship: Audit Risk vs. Materiality
| Materiality Level | Extent of Procedures | Audit Risk |
|---|---|---|
| High | More extensive | Decreases ↓ |
| Low | Less extensive | Increases ↑ |
Inverse relationship between materiality and audit risk.
Considered throughout the audit, particularly when:
- Identifying and assessing RMM
- Determining NTE of FAP
- Evaluating effect of uncorrected misstatements
- Forming the opinion in the auditor's report
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### Determining Materiality — Key Principle
Planning materiality does not automatically make everything below it immaterial. The auditor must consider:
- Size of misstatement
- Nature of misstatement
- Circumstances of occurrence
Some misstatements below the threshold may still be evaluated as material based on their nature.
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### Revision of Materiality
If new information comes to light during the audit that would have led to a different initial materiality, the auditor must revise:
1. Materiality for FS as a whole
2. Performance materiality (if revised materiality is lower)
3. NTE of Further Audit Procedures
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### Benchmarking
A percentage applied to a chosen benchmark is the starting point.
Factors in selecting the right benchmark:
| Factor | Consideration |
|---|---|
| Element of FS | Assets, liabilities, expenses |
| User focus | Profit/revenue for performance evaluation |
| Ownership structure | Debt-financed → users focus on assets; equity-financed → focus on earnings |
| Entity lifecycle & environment | Growth vs. mature entity |
| Volatility of benchmark | If PBT is volatile, use gross profit or total revenues instead |
Typical percentage benchmarks:
- Profit-oriented entity: ~5% of Profit Before Tax
- Not-for-profit entity: ~1% of total revenue or total expenses
> Note: Percentage applied to PBT is normally higher than percentage applied to total revenue (because revenue is a far larger base number).
Financial data used for benchmarking:
- Prior period financial results and financial positions
- Period-to-date results and budgets/forecasts for the current period
- Adjusted for significant changes (e.g., a business acquisition) and industry/economic environment changes
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### Materiality for Specific Classes, Balances, or Disclosures
Lower (item-specific) materiality thresholds apply when:
1. Law or FRF affects user expectations regarding specific items (e.g., RPTs, managerial remuneration)
2. Key industry disclosures are involved (e.g., R&D expenses in a pharmaceutical company)
3. A particular aspect of the business is separately disclosed in the FS (e.g., newly acquired business)
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### Documentation Requirements
The auditor must document:
a. Materiality for the FS as a whole
b. Materiality for specific classes/balances/disclosures (if applicable)
c. Performance materiality
d. Any revision of (a) to (c) as the audit progressed