SA 320

MATERIALITY IN PLANNING AND PERFORMANCE AN AUDIT

Q.NO.1 WRITE ABOUT THE CONCEPT OF MATERIALITY?

ANSWER:

1. Financial statements should disclose all ‘material items, i.e., the items the knowledge of which might
influence the decisions of the user of the financial statement.

2. Materiality is not always a matter of relative size.

For example, a small amount lost by fraudulent practices of certain employees can indicate a serious
flaw in the enterprise’s internal control system requiring immediate attention to avoid greater losses
in future.

3. In certain cases, quantitative limits of materiality is specified. A few of such cases are given below:
a. A company should disclose by way of notes additional information regarding any item of
income or expenditure which exceeds 1% of the revenue from operations or Rs.1,00,000
whichever is higher (Schedule III to the Companies Act, 2013).
b. A company should disclose in Notes to Accounts, shares in the company held by each
shareholder holding more than 5 % shares specifying the number of shares held.

4. Standard on Auditing (SA) -320 on “Materiality in Planning and Performing an Audit” deals with the
auditor’s responsibility to apply the concept of materiality in planning and performing an audit of
financial statements. SA 450 explains how materiality is applied in evaluating the effect of identified
misstatements on the audit and of uncorrected misstatements on the financial statements.

5. MATERIALITY IF FRFW DO NOT CONTAIN ANY REFERENCE THERETO: 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:
a. Misstatements are material if expected to influence the economic decisions of users taken on
the basis of the financial statements.
b. Judgments about materiality are affected by the size or nature of a misstatement or
combination of both.
c. Judgments about matters that are material are based on a consideration of the common
financial information needs of users as a group. The possible effect of misstatements on
specific individual users, whose needs may vary widely, is not considered.

If the applicable financial reporting framework does not include a discussion of the concept of
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materiality, the characteristics referred above provide the auditor with such a frame of reference.
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SHRESHTA For CA and CMA | SA 320 Extracted from CA Inter P6 Auditing | Nov 2023 and May 2024
Q.NO.2 DETERMINATION OF MATERIALITY IS A MATTER OF PROFESSIONAL JUDGMENT OF AUDITOR.
COMMENT.

ANSWER:

The auditor’s determination of materiality is a matter of professional judgment, and is affected by the
auditor’s perception of the financial information needs of users of the financial statements. In this
context, it is reasonable for the auditor to assume that users:
1. 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.
2. Understand that financial statements are prepared, presented and audited to levels of materiality.
3. Recognize the uncertainties inherent in the measurement of amounts based on the use of estimates,
judgment and the consideration of future events and
4. Make reasonable economic decisions on the basis of the information in the financial statements.

Q.NO.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. COMMENT.

ANSWER:

1. Materiality is an important consideration for an auditor to evaluate whether the financial statements
reflect a true and fair view or not.
2. SA 320 on “Materiality in Planning and Performing an Audit” requires that an auditor should consider
materiality and its relationship with audit risk while conducting an audit.
3. When planning the audit, the auditor considers what would make the financial information materially
misstated.
4. The auditor’s preliminary assessment of materiality related to specific account balances and classes of
transactions helps the auditor decide such questions as what items to examine and whether to use
sampling and analytical procedures.
5. This enables the auditor to select audit procedures that, in combination, can be expected to support
the audit opinion at an acceptably low degree of audit risk.
6. It may be noted that the auditor’s assessment of materiality and audit risk may be different at the
time of initially planning of the audit as against at the time of evaluating the results of audit
procedures.
7. At the planning stage, the auditor needs to consider the materiality for the financial statements as a
whole. The auditor has to carry out a preliminary identification of significant components and material
classes of transactions, account balances and disclosure which he plans to examine.
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8. What could be considered material for all situations cannot be defined precisely and an amount or
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transaction material in one situation may not be material in other situation.

SHRESHTA For CA and CMA | SA 320 Extracted from CA Inter P6 Auditing | Nov 2023 and May 2024
9. For example, Rs. 5,000 may be material for a small entity, but even Rs. 100,000 may not be material
for a large entity.
10. The auditor has to apply his professional judgement in determining materiality, choosing appropriate
benchmark and determining level of benchmark.
11. Materiality forms the basis for determination of audit scope and the levels of testing the transactions.
12. If there is any statutory requirement of disclosure, it is to be considered material irrespective of the
value of amount.

Example:
As per new Division I schedule III of Companies Act, 2013, any item of income or expenditure which
exceeds one percent of the revenue from operations or Rs. 1,00,000, whichever is higher, needs to be
disclosed separately.

Q.NO.4 WRITE ABOUT PERFORMANCE MATERIALITY?

ANSWER:

1. When establishing the overall audit strategy, the auditor shall determine materiality for the financial
statements as a whole.
2. 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.

3. PERFORMANCE MATERIALITY: 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.

Q.NO.5 WRITE ABOUT USE OF BENCHMARKS IN DETERMINING MATERIALITY FOR THE FINANCIAL
STATEMENTS AS A WHOLE?

ANSWER:

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.
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Factors that may affect the identification of an appropriate benchmark include the following:
SHRESHTA For CA and CMA | SA 320 Extracted from CA Inter P6 Auditing | Nov 2023 and May 2024
1. The elements of the financial statements.
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
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

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;

5. The relative volatility of the benchmark.

Example: 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.

Q.NO.6 WRITE ABOUT EXAMPLES OF BENCHMARKS THAT HELPS IN DETERMINGING MATERIALITY?

ANSWER:

Examples of benchmarks that may be appropriate, depending on the circumstances of the entity, include
categories of reported income such as:
1. Profit before tax,
2. Total revenue,
3. Gross profit and total expenses,
4. Total equity or net asset value.

SELECTION OF CHOOSEN BENCHMARK: In relation to the chosen benchmark, relevant financial data
ordinarily includes:
1. Prior periods’ financial results and financial positions,
2. The period to-date financial results and financial position, and
3. 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.
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EXAMPLE:
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SHRESHTA For CA and CMA | SA 320 Extracted from CA Inter P6 Auditing | Nov 2023 and May 2024
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 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.
APPLY A PERCENTAGE ON CHOOSEN BENCHMARK: 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.

Q.NO.7 WRITE ABOUT MATERIALITY LEVEL OR LEVELS FOR PARTICULAR CLASSES OF TRANSACTIONS,
ACCOUNT BALANCES OR DISCLOSURES?

ANSWER:

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:

1. Whether law, regulations or the applicable financial reporting framework affect users’ expectations
regarding the measurement or disclosure of certain items.
Example: Related party transactions, and the remuneration of management and those charged with
governance.

2. The key disclosures in relation to the industry in which the entity operates.
Example: Research and development costs for a pharmaceutical company.

3. Whether attention is focused on a particular aspect of the entity’s business that is separately
disclosed in the financial statements.
Example: A newly acquired business.

Q.NO.8 WRITE ABOUT REVISION AND DOCUMENTATION OF MATERIALITY?

ANSWER:

REVISION IN MATERIALITY LEVEL:

The overall materiality and performance materiality may need to be changed as the audit progresses in
the following cases:
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1. A change in circumstances that occurred during the audit.

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2. Availability of additional information.

SHRESHTA For CA and CMA | SA 320 Extracted from CA Inter P6 Auditing | Nov 2023 and May 2024
3. A change in actual financial results than the anticipated results at the beginning of the audit.
4. Increase in estimated risk than the original prediction resulting in revision of materiality level.
5. A change in auditor’s knowledge of client’s business and understanding of the same.

DOCUMENTATION OF MATERIALITY:

The auditor shall document the following:

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

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.
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
performance materiality, and whether the nature, timing and extent of the further audit procedures
remain appropriate.

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SHRESHTA For CA and CMA | SA 320 Extracted from CA Inter P6 Auditing | Nov 2023 and May 2024