SA 320 Materiality

SA 320
Materiality in Planning and
Performing an Audit
(Effective for audits of financial statements for periods
beginning on or after April 1, 2010)

Contents
Paragraph(s)
Introduction
Scope of this SA........................................................................................ 1
Materiality in the Context of an Audit ..................................................... 2-6
Effective Date ............................................................................................ 7
Objective. ................................................................................................. 8
Definition .................................................................................................. 9
Requirements
Determining Materiality and Performance Materiality when
Planning the Audit .............................................................................. 10-11
Revision as the Audit Progresses ..................................................... 12-13
Documentation ........................................................................................ 14
Application and Other Explanatory Material
Materiality and Audit Risk ....................................................................... A1
Determining Materiality and Performance Materiality when
Planning the Audit ........................................................................... A2-A12
Revision as the Audit Progresses ......................................................... A13
Material Modifications to ISA 320, “Materiality in Planning and
Performing an Audit”
Standard on Auditing (SA) 320, “Materiality in Planning and Performing
an Audit” should be read in the context of the “Preface to the Standards
on Quality Control, Auditing, Review, Other Assurance and Related
Services,” which sets out the authority of SAs and SA 200, “Overall
Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing”.

 Published in August, 2009 issue of the Journal.
Handbook of Auditing Pronouncements-I.A

Introduction
Scope of this SA
1. This Standard on Auditing (SA) deals with the auditor’s responsibility to
apply the concept of materiality in planning and performing an audit of financial
statements. SA 4501, explains how materiality is applied in evaluating the effect
of identified misstatements on the audit and of uncorrected misstatements, if any,
on the financial statements.
Materiality in the Context of an Audit
2. Financial reporting frameworks often discuss the concept of materiality in
the context of the preparation and presentation of financial statements. Although
financial reporting frameworks may discuss materiality in different terms, they
generally explain that:
 Misstatements, including omissions, are considered to be material if they,
individually or in the aggregate, could reasonably be expected to influence
the economic decisions of users taken on the basis of the financial
statements;
 Judgments about materiality are made in the 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.2 The possible effect of
misstatements on specific individual users, whose needs may vary widely,
is not considered.
3. Such a discussion, if present in the applicable financial reporting
framework, provides a frame of reference to the auditor in determining materiality
for the audit. If the applicable financial reporting framework does not include a
discussion of the concept of materiality, the characteristics referred to in
paragraph 2 provide the auditor with such a frame of reference.
4. The auditor’s determination of materiality is a matter of professional
judgment, and is affected by the auditor’s perception of the financial information

1 SA 450, “Evaluation of Misstatements Identified during the Audit”.
2 For example, paragraph 10 of the “Framework for the Preparation and Presentation of Financial

Statements,” issued by the Institute of Chartered Accountants of India (ICAI) in July 2000, indicates
for a profit-oriented entity that “as providers 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”.

SA 320 2
needs of users of the financial statements. In this context, it is reasonable for the
auditor to assume that users:
(a) 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;
(b) Understand that financial statements are prepared, presented and audited
to levels of materiality;
(c) Recognize the uncertainties inherent in the measurement of amounts
based on the use of estimates, judgment and the consideration of future
events; and
(d) Make reasonable economic decisions on the basis of the information in the
financial statements.
5. 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. (Ref: Para. A1)
6. In planning the audit, the auditor makes judgments about the size of
misstatements that will be considered material. These judgments provide a basis
for:
(a) Determining the nature, timing and extent of risk assessment procedures;
(b) Identifying and assessing the risks of material misstatement; and
(c) Determining the nature, timing and extent of further audit procedures.
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. Although, it is not practicable to design audit
procedures to detect misstatements that could be material solely because of their
nature, 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.3
Effective Date
7. This SA is effective for audits of financial statements for periods beginning
on or after April 1, 2010.

3 SA 450, paragraph A16.

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Handbook of Auditing Pronouncements-I.A

Objective
8. The objective of the auditor is to apply the concept of materiality
appropriately in planning and performing the audit.
Definition
9. For purposes of the SAs, 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. If applicable, performance materiality also refers
to the amount or amounts set by the auditor at less than the materiality level or
levels for particular classes of transactions, account balances or disclosures.
Requirements
Determining Materiality and Performance Materiality when Planning
the Audit
10. When establishing the overall audit strategy, the auditor shall determine
materiality for the financial statements as a whole. 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. (Ref: Para. A2-A11)
11. 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. (Ref: Para. A12)
Revision as the Audit Progresses
12. The auditor shall revise materiality for the financial statements as a whole
(and, if applicable, the materiality level or levels for particular classes of
transactions, account balances or disclosures) in the event of becoming aware of
information during the audit that would have caused the auditor to have
determined a different amount (or amounts) initially. (Ref: Para. A13)
13. If the auditor concludes that a lower materiality for the financial statements
as a whole (and, if applicable, materiality level or levels for particular classes of
transactions, account balances or disclosures) than that initially determined is
appropriate, the auditor shall determine whether it is necessary to revise
SA 320 4
performance materiality, and whether the nature, timing and extent of the further
audit procedures remain appropriate.
Documentation
14. The audit documentation shall include the following amounts and the
factors considered in their determination:
(a) Materiality for the financial statements as a whole (see paragraph 10);
(b) If applicable, the materiality level or levels for particular classes of
transactions, account balances or disclosures (see paragraph 10);
(c) Performance materiality (see paragraph 11); and
(d) Any revision of (a)-(c) as the audit progressed (see paragraphs 12-13).
***
Application and Other Explanatory Material
Materiality and Audit Risk (Ref: Para. 5)
A1. In conducting an audit of financial statements, the overall objectives of the
auditor are to obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatement, whether due to fraud
or error, thereby enabling the auditor to express an opinion on whether the
financial statements are prepared, in all material respects, in accordance with an
applicable financial reporting framework; and to report on the financial
statements, and communicate as required by the SAs, in accordance with the
auditor’s findings.4 The auditor obtains reasonable assurance by obtaining
sufficient appropriate audit evidence to reduce audit risk to an acceptably low
level5. Audit risk is the risk that the auditor expresses an inappropriate audit
opinion when the financial statements are materially misstated. Audit risk is a
function of the risks of material misstatement and detection risk6. Materiality and
audit risk are considered throughout the audit, in particular, when:
(a) Identifying and assessing the risks of material misstatement7;
(b) Determining the nature, timing and extent of further audit procedures8; and
(c) Evaluating the effect of uncorrected misstatements, if any, on the financial
statements and in forming the opinion in the auditor’s report9.

4 SA 200, paragraph 11.
5 SA 200, paragraph 17.
6 SA 200, paragraph 13(c).
7 SA 315, “Identifying and Assessing the Risks of Material Misstatements Through Understanding

the Entity and Its Environment”.
8 SA 330, “The Auditor’s Responses to Assessed Risks”.
9 SA 700 (Revised), “Forming an Opinion and Reporting on Financial Statements”.

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Determining Materiality and Performance Materiality when Planning
the Audit (Ref: Para. 10)
Use of Benchmarks in Determining Materiality for the Financial Statements
as a Whole
A2. 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:
 The elements of the financial statements (for example, assets, liabilities,
equity, revenue, expenses);
 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);
 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 (for example, if
an entity is financed solely by debt rather than equity, users may put more
emphasis on assets, and claims on them, than on the entity’s earnings);
and
 The relative volatility of the benchmark.
A3. Examples of benchmarks that may be appropriate, depending on the
circumstances of the entity, include categories of reported income such as profit
before tax, total revenue, gross profit and total expenses, total equity or net asset
value. Profit before tax from continuing operations is often used for profit-oriented
entities. When profit before tax from continuing operations is volatile, other
benchmarks may be more appropriate, such as gross profit or total revenues.
A4. In relation to the chosen benchmark, relevant financial data ordinarily
includes prior periods’ financial results and financial positions, the period-to-date
financial results and financial position, and budgets or forecasts for the current
period, adjusted for significant changes in the circumstances of the entity (for
example, a significant business acquisition) and relevant changes of conditions
in the industry or economic environment in which the entity operates. For
example, when, as a starting point, the materiality for the financial statements as
a whole is determined for a particular entity based on a percentage of profit
before tax from continuing operations, circumstances that give rise to an
exceptional decrease or increase in such profit may lead the auditor to conclude

SA 320 6
that the materiality for the financial statements as a whole is more appropriately
determined using a normalized profit before tax from continuing operations figure
based on past results.
A5. Materiality relates to the financial statements on which the auditor is
reporting. Where the financial statements are prepared for a financial reporting
period of more or less than twelve months, such as may be the case for a new
entity or a change in the financial reporting period, materiality relates to the
financial statements prepared for that financial reporting period.
A6. Determining a percentage to be applied to a chosen benchmark involves
the exercise of professional judgment. There is a relationship between the
percentage and the chosen benchmark, such that a percentage applied to profit
before tax from continuing operations will normally be higher than a percentage
applied to total revenue. For example, the auditor may consider five percent of
profit before tax from continuing operations to be appropriate for a profit oriented
entity in a manufacturing industry, while the auditor may consider one percent of
total revenue or total expenses to be appropriate for a not-for-profit entity. Higher
or lower percentages, however, may be deemed appropriate in different
circumstances.
Considerations Specific to Small Entities
A7. When an entity’s profit before tax from continuing operations is consistently
nominal, as might be the case for an owner-managed business where the owner
takes much of the profit before tax in the form of remuneration, a benchmark
such as profit before remuneration and tax may be more relevant.
A8. In the case of certain entities, such as, Central/State governments and
related government entities (for example, agencies, boards, commissions),
legislators and regulators are often the primary users of its financial statements.
Furthermore, the financial statements may be used to make decisions other than
economic decisions. The determination of materiality for the financial statements
as a whole (and, if applicable, materiality level or levels for particular classes of
transactions, account balances or disclosures) in an audit of the financial
statements of those entities may therefore be influenced by legislative and
regulatory requirements, and by the financial information needs of legislators and
the public in relation to public utility programs/projects, such as, Accelerated
Irrigation Benefit Programme (AIBP), Pradhan Mantri Gram Sadak Yojana
(PMGSY) undertaken by the Central/State governments or related government
entities .
A9. In an audit of the entities doing public utility programs/projects, total cost or
net cost (expenses less revenues or expenditure less receipts) may be

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appropriate benchmarks for that particular program/project activity. Where an
entity has custody of the assets, assets may be an appropriate benchmark.
Materiality Level or Levels for Particular Classes of Transactions, Account
Balances or Disclosures (Ref: Para. 10)
A10. Factors that may indicate the existence of one or more particular classes of
transactions, account balances or disclosures for which misstatements of lesser
amounts than 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 include the following:
 Whether law, regulations or the applicable financial reporting framework
affect users’ expectations regarding the measurement or disclosure of
certain items (for example, related party transactions, and the remuneration
of management and those charged with governance).
 The key disclosures in relation to the industry in which the entity operates
(for example, research and development costs for a pharmaceutical
company).
 Whether attention is focused on a particular aspect of the entity’s business
that is separately disclosed in the financial statements (for example, a
newly acquired business).
A11. In considering whether, in the specific circumstances of the entity, such
classes of transactions, account balances or disclosures exist, the auditor may
find it useful to obtain an understanding of the views and expectations of those
charged with governance and management.
Performance Materiality (Ref: Para. 11)
A12. Planning the audit solely to detect individually material misstatements
overlooks the fact that the aggregate of individually immaterial misstatements
may cause the financial statements to be materially misstated, and leaves no
margin for possible undetected misstatements. Performance materiality (which,
as defined, is one or more amounts) is set to reduce to an appropriately low level
the probability that the aggregate of uncorrected and undetected misstatements
in the financial statements exceeds materiality for the financial statements as a
whole. Similarly, performance materiality relating to a materiality level determined
for a particular class of transactions, account balance or disclosure is set to
reduce to an appropriately low level the probability that the aggregate of
uncorrected and undetected misstatements in that particular class of
transactions, account balance or disclosure exceeds the materiality level for that
particular class of transactions, account balance or disclosure. The determination

SA 320 8
of performance materiality is not a simple mechanical calculation and involves
the exercise of professional judgment. It is affected by the auditor’s
understanding of the entity, updated during the performance of the risk
assessment procedures; and the nature and extent of misstatements identified in
previous audits and thereby the auditor’s expectations in relation to
misstatements in the current period.
Revision as the Audit Progresses (Ref: Para. 12)
A13. Materiality for the financial statements as a whole (and, if applicable, the
materiality level or levels for particular classes of transactions, account balances
or disclosures) may need to be revised as a result of a change in circumstances
that occurred during the audit (for example, a decision to dispose of a major part
of the entity’s business), new information, or a change in the auditor’s
understanding of the entity and its operations as a result of performing further
audit procedures. For example, if during the audit it appears as though actual
financial results are likely to be substantially different from the anticipated period
end financial results that were used initially to determine materiality for the
financial statements as a whole, the auditor revises that materiality.
Material Modifications to ISA 320, “Materiality in Planning
and Performing an Audit”
Deletions
1. Paragraph A3 of ISA 320 (A8 of SA 320) dealt with the determination of
materiality for the financial statements as a whole or for particular assertion in an
audit of financial statements of a public sector entity, which is influenced by
legislative and regulatory requirements, and by the financial information needs of
legislators and the public in relation to public sector programs. Since as
mentioned in the “Preface to the Standards on Quality Control, Auditing, Review,
Other Assurance and Related Services”, the Standards issued by the Auditing
and Assurance Standards Board, apply equally to all entities, irrespective of their
form, nature and size, a specific reference to applicability of the Standard to
public sector entities has been deleted.
Further, it is also possible that such a specific situation may exist in case of
Central/State governments or related government entities, or programs/projects
launched by them, pursuant to a requirement under the statute or regulation
under which they operate. Accordingly, the spirit of Paragraph A3 in ISA,
highlighting such fact, has been retained and the paragraph has been re-
numbered as A8.

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2. Paragraph A10 of ISA 320(A9 of SA 320) states that in an audit of the
public sector entities, total cost or net cost (expenses less revenues or
expenditure less receipts) may be appropriate benchmarks for program/project
activities. Where a public sector entity has custody of assets, assets may be an
appropriate benchmark. Since as mentioned in the “Preface to the Standards on
Quality Control, Auditing, Review, Other Assurance and Related Services”, the
Standards issued by the Auditing and Assurance Standards Board, apply equally
to all entities, irrespective of their form, nature and size, a specific reference to
applicability of the Standard to public sector entities has been deleted.
Further, it is also possible that such a specific situation may exist in case of
Central/State governments or related government entities, or programs/projects
launched by them, pursuant to a requirement under the statute or regulation
under which they operate. Accordingly, the spirit of Paragraph A10 in ISA,
highlighting such fact, has been retained.

SA 320 10