Materiality is the auditor's answer to a very practical question: How big does an error have to be before it matters? Think of it this way — if Rajesh & Co. Pvt. Ltd. has revenue of ₹50 crores and there's a ₹500 misstatement buried in stationery expenses, you're not going to lose sleep over it. But a ₹2 crore error in revenue recognition? That changes the picture entirely for any investor or banker reading those financials.
SA 320 requires the auditor to set Overall Materiality (OM) at the planning stage — a rupee threshold above which a misstatement would reasonably influence the decisions of users. The standard doesn't give you a magic formula, but in practice auditors use benchmarks: commonly 5% of profit before tax for profit-oriented companies, or 0.5%–1% of total assets / total revenue when profits are volatile or near zero. Then there's Performance Materiality (PM) — always lower than OM, typically set at 50%–75% of OM. Why lower? Because the auditor needs a safety buffer — multiple small uncorrected errors could together cross OM, so PM gives room to catch them individually. For example, if OM is ₹20 lakhs, PM might be ₹12–14 lakhs. Additionally, SA 320 allows Specific Materiality for certain sensitive areas — related-party transactions, directors' remuneration, or regulatory compliance items — where even a small misstatement could be significant regardless of size.
Critically, materiality is not a one-time calculation. SA 320 explicitly requires the auditor to revise materiality if, during the audit, they learn new information — say, profits turn out to be much lower than expected, making the original benchmark incorrect. If materiality is revised downward, more testing may be needed. Also remember: materiality applies to omissions and disclosures, not just numbers — a missing contingent liability note can be material even if it's zero in the ledger. This is asked frequently as a 4–6 mark question, especially the distinction between overall materiality and performance materiality, and why PM is set lower.