## SA 320 – Materiality
### Definition
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.
> Key insight: Materiality is not always a matter of relative size. A small fraud amount may indicate a serious flaw in internal controls requiring immediate attention.
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### Auditor's Responsibilities Under SA 320
The auditor applies the concept of materiality at three stages:
| Stage | Purpose |
|---|---|
| Planning | Set materiality to design risk assessment and further audit procedures |
| Performance | Identify and assess risks of material misstatement |
| Reporting | Evaluate effect of uncorrected misstatements on the FS and the audit opinion |
Judgements derived from planning materiality:
a) Nature, extent, and timing of risk assessment procedures
b) Nature, extent, and timing of further audit procedures
c) Identification and assessment of risks of material misstatement
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### Reasonable User Assumption (Professional Judgement Basis)
When determining materiality, the auditor assumes users:
- Have reasonable knowledge of business, economics, and accounting.
- Are willing to study the FS with reasonable diligence.
- Understand FS are prepared and audited to levels of materiality.
- Recognise inherent uncertainties in estimates and judgements.
- Make reasonable economic decisions based on the FS.
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### Performance Materiality (PM)
Why it exists: Individual tests cannot always detect misstatements that are immaterial alone but material in aggregate.
Definition: PM is the amount(s) set by the auditor at less than overall materiality to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds overall materiality.
Key rule: PM < Overall Materiality (always).
Special situation – specific account/class/disclosure:
If misstatements below overall materiality could still influence user decisions for a specific account balance (A), class of transaction (B), disclosure (C), or other item (D), the auditor shall determine a separate materiality for each of those ABCD items.
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### Benchmarks (BM)
A percentage applied to a benchmark determines materiality for the FS as a whole.
Common benchmarks:
- Profit Before Tax (PBT)
- Total Revenue
- Gross Profit
- Total Expenses
- Total Equity / Net Asset Value
Factors that affect benchmark selection:
| Factor | Explanation |
|---|---|
| Elements of FS | Assets, Liabilities, Equity, Revenue, Expenses |
| User focus | What do users pay attention to? (e.g., profit for performance evaluation) |
| Nature of entity | Industry, economic environment, ownership structure, financing |
| Volatility | More volatile benchmarks may be less appropriate |
Relevant financial data for the chosen BM:
- Prior-period financial results
- Period-to-date financial results
- Budget or forecasts for the current period
- Adjustments for significant changes (e.g., business acquisitions, changed economic environment)
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### Determining the Percentage – Professional Judgement
There is a relationship between the percentage and the benchmark:
- Higher percentage → applied to smaller/more volatile bases like PBT from continuing operations (e.g., ~5%)
- Lower percentage → applied to larger bases like total revenue or total expenses (e.g., ~1%)
Reason: PBT is a narrower number; a 5% error in PBT is proportionally equivalent to a 1% error in total revenue for many entities.
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### Documentation
The auditor must document:
- Materiality for the FS as a whole
- Performance Materiality
- Any revisions to materiality made during the audit
- The benchmark chosen and the reasoning