SA 320-Materiality in Planning and Performing an Audit (Effective 01/04/2010)

1. 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; 
2. Materiality is a matter of professional judgement
3. 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.

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:

1. The elements of the financial statements (for example, assets, liabilities, equity, revenue, expenses);
2. 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);
3. 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;
4. 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
5. The relative volatility of the benchmark.

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.

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.

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 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).

1. The auditor shall revise materiality for the financial statements as a whole (or 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. 
2. If the auditor concludes that a lower materiality for the financial statements as a whole (or 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 performance materiality, and whether the nature, timing and extent of the further audit procedures remain appropriate.

The audit documentation shall include the following amounts and the factors considered in their determination:

1. Materiality for the financial statements as a whole 
2. If applicable, the materiality level or levels for particular classes of transactions, account balances or disclosures 
3. Performance materiality and
4. Any revision of (a)-(c) as the audit progressed 

To get detailed understanding of the concept you can consider purchasing our Audit classes from here – https://lecturepedia.in/product/ca-final-audit-fastrack-classes-for-nov-2023-onward-exams-by-ca-balakrishna-kovuru/