Materiality: ISA 320

An auditor does not chase every error. The question is always whether an error is big enough, or important enough, to change a user’s decision. That test is materiality, and it decides how much work is done, which items get attention and which misstatements must be corrected or reported.

This topic covers the idea of materiality, the usual thresholds and their dangers, what International Standard on Auditing (ISA) 320 requires at planning, performance materiality, how to choose a benchmark, and the qualitative factors that make a small item material. Examiners ask for the factors in choosing a benchmark, as in May 2026 (4 marks), and they test whether you can see that a small item can still be material.

In the November 2025 Section B case, a materiality level of 10% of profit before tax was called too high for a low-margin client.

The concept of materiality

The International Accounting Standards Board (IASB) Framework says that information is material if its omission or misstatement could influence the economic decisions that users take on the basis of the financial statements. ISA 320 Materiality in planning and performing an audit deals with the auditor’s responsibility to apply the concept.

The revised ISA makes clear that materiality depends on the size and nature of an item, judged in the surrounding circumstances.

Materiality is always a matter of the auditor’s judgement applied to the facts of a particular case. There are guidelines on materiality, but there are no rules.

Materiality is relative

What is material for one company may not be for another. An unrecorded sales invoice of ₦10,000 is unlikely to be material to a multinational with revenue of many millions. It would probably be material to a small company with annual revenue of ₦300,000. Even in a large company a small error must be considered with care, because one error may point to others that together are material.

Materiality thresholds

To deal with materiality consistently, most firms set their own thresholds, and staff are trained to use them. They differ between firms but usually fall in these ranges.

The danger of thresholds

The danger is using a threshold simply to measure whether an item is material, without considering other factors. The auditor should also consider:

• The item involved. Some items are more subjective than others and depend on estimation. The auditor takes a more flexible view of a warranty provision, a subjective estimate, than of share capital, which can be measured precisely.
• The significance of the item. An item may be small in amount yet of particular interest to users. Bonus payments to directors are an example.
• The effect on the view presented. A small, apparently minor error may be material if correcting it would turn a reported profit into a loss, or would significantly change the trend of profits over recent years.

ISA 320: materiality in planning and performing an audit

ISA 320 requires the auditor to apply materiality:

1. when planning and performing the audit; and
2. when evaluating the effect of misstatements on the financial statements and so on the audit opinion. That is covered in the later topic on evaluating misstatements under ISA 450.

At the planning stage

The auditor determines materiality for the financial statements as a whole. This is often done by applying the thresholds above. If lower thresholds are needed for some areas, such as directors’ remuneration, they are also set at this stage.

Performance materiality

The auditor also sets performance materiality. If every area were tested to find errors only above overall materiality, the individual errors that were below the level and undetected could add up to more than overall materiality. Performance materiality takes this risk into account. It is set at a lower figure than overall materiality, and there may be one or more levels because the level can vary by area.

Revision and documentation

As the audit progresses, the auditor must revise materiality, and where appropriate materiality for particular areas and performance materiality, if he learns of information that would have led him to set different levels at the start. The documentation must show all materiality levels set and any revision of them.

Choosing a benchmark

Setting overall materiality means choosing a benchmark and a percentage. The factors that affect which benchmark is appropriate are:

1. The elements of the financial statements. Assets, liabilities, equity, revenue and expenses.
2. What users focus on. Users judging performance usually look at profit, revenue or net assets.
3. The nature of the entity. Its stage in the life cycle, its industry and the economic environment.
4. Ownership and financing. If an entity is financed wholly by debt and not equity, users may put more weight on assets and the claims on them than on earnings.
5. The volatility of the benchmark. A benchmark that swings widely from year to year gives an unstable materiality.

Background: These five come from the May 2026 model solution and from the application material in ISA 320. Where a company has losses or only small profits, profit before tax is a poor benchmark, and the auditor turns to revenue, total assets or expenses, with a suitable percentage.

Other matters in judging materiality

Background: Four further issues are often named without being explained. They are useful in an exam answer.

• Degree of approximation. The more an item depends on estimation, the greater the likely difference and the more flexible the auditor’s view.
• Critical points. Levels at which something changes, such as a loan covenant limit, a profit target or the move from loss to profit.
• Offset and aggregation. Individually small misstatements may add up to a material amount. Misstatements that offset each other still show weakness in the process, and the auditor should be careful about netting them.
• Losses or low profits. A percentage of a tiny or negative profit is not a sound guide, so another benchmark is used.

Directors’ responsibilities appear in the quiz as a distractor. They have little to do with setting materiality.

The rules in more depth

Why size and nature both count

A figure that is small against revenue may still matter because of what it is. A payment to a director, a related party transaction, a breach of law or a breach of a loan covenant may be of interest to users whatever the amount. Size alone is not enough to judge the item.

Why performance materiality is lower

Overall materiality is the level at which the financial statements as a whole are misleading. The auditor cannot find every error. If the work only targeted errors up to overall materiality, then small undetected errors across many balances would add up. A lower working level gives a margin, so that the total of the undetected and uncorrected errors stays below overall materiality.

Why materiality affects the amount of testing

A lower level means that more items must be tested, because smaller errors matter. Sample sizes grow and more balances are in scope. A higher level reduces work. That is why a materiality set too high in a low-margin client is dangerous: the work is too thin and material errors are missed.

Why materiality is revised

Materiality is set early, on the draft figures and the expectation of results. If actual profit turns out much lower, or the entity’s circumstances change, the original level may be wrong. Revising it keeps the work in line with what users now care about.

Worked example: setting materiality for a low-margin client

1. Apply the ranges. Revenue at 1% to 2% gives ₦80 million to ₦160 million. Total assets at 1% to 2% gives ₦50 million to ₦100 million. Profit before tax at 5% to 10% gives ₦7.5 million to ₦15 million.
2. Compare. The revenue and asset figures are huge against profit. An error of ₦80 million would remove more than half of the profit. The wholesaler’s margin is only about 1.9% of revenue, so a revenue-based figure would not protect users who watch profit.
3. Choose the benchmark. Users, the bank and shareholders, focus on profit. But profit has halved from last year, so it is volatile, and a percentage at the top of the range would be too high for a low-margin business. Use profit before tax, at a percentage towards the lower half of the range, with a check against revenue and assets.
4. Set the levels. Overall materiality of ₦10 million, which is about 6.7% of profit before tax and about 0.1% of revenue. Performance materiality of ₦7 million, about 70% of overall. A lower level, say ₦1 million, for directors’ remuneration, and a clearly trivial threshold of ₦500,000 below which differences are not accumulated.
5. Other decisions. Because profit is volatile, review the level when the year’s final profit is known. Record the benchmark, the percentage, the reasons and any revision.

Conclusion. A modest percentage of profit gives a figure that protects users, and the lower performance level keeps the total of undetected errors under control.

How to score full marks

• For “factors in choosing a benchmark”, give five and add a short reason to each. Name the focus of users, ownership and financing, and volatility, because candidates often forget them.
• For thresholds, quote the three ranges, then add the warnings about the item, its significance and its effect on the view presented.
• For “is this item material”, test it for size and for nature. Ask whether it turns profit into loss, hides a trend, involves directors or breaches a covenant.
• For ISA 320, give overall materiality, lower levels for specific areas, performance materiality, revision and documentation.
• Say what the level does to the work. Lower materiality means more testing.
• In a case, use the numbers given and say whether the level is too high or too low.
• Time. Spend time in proportion to marks.

Common mistakes in the exam

• Applying a percentage mechanically and ignoring the nature of the item.
• Using 10% of pre-tax profit for a client with a low margin without comment.
• Confusing overall materiality with performance materiality.
• Forgetting that materiality is revised during the audit.
• Saying that a small error can be ignored because it is below the threshold, without testing its nature or its effect on profit.
• Choosing profit as the benchmark where profit is a small loss.
• Forgetting to document the levels set.

Quick revision

• Material: could influence users’ economic decisions. Size and nature. Relative. Judgement, no rules.
• Thresholds: revenue 1% to 2%, pre-tax profit 5% to 10%, total assets 1% to 2%.
• Beyond the numbers: the item involved, its significance, its effect on the view presented.
• ISA 320: set overall materiality, lower levels where needed, set performance materiality, revise, document.
• Benchmark factors: elements of the statements, users’ focus, nature of entity, ownership and financing, volatility.
• Lower materiality: more testing and larger samples.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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