How to Set Materiality for Different Industries: ISA 320 Benchmarks

Your firm audits a mid-sized manufacturer, a regional bank, a housing association, and a municipality. All four need materiality calculated this month. Same standard, four different benchmarks, four different percentage ranges. If you're reaching for the same benchmark every time, you're doing it wrong.

Setting materiality under ISA 320 requires selecting a benchmark appropriate to the entity's circumstances (ISA 320.10) and applying a percentage within the accepted range for that entity type (ISA 320.A3-A7), then adjusting for qualitative factors that may warrant a lower figure.

The materiality calculator on ciferi.com includes 13 industry presets that automate the benchmark selection and percentage range for common entity types.

ISA 320.10: the benchmark selection requirement

ISA 320.10 requires the auditor to determine materiality for the financial statements as a whole when establishing the overall audit strategy. The standard does not prescribe a single benchmark. Instead, ISA 320.A3 provides a list of benchmarks that may be appropriate depending on the entity's circumstances: profit before tax from continuing operations, total revenue, gross profit, total expenses, total equity, and net asset value.

The choice of benchmark is an auditor judgment. ISA 320.A4 explains that the selected benchmark should be a measure that users of the financial statements would regard as significant to their decision-making. For a profit-oriented entity where profit is stable, profit before tax is often the starting point. For an entity where profit fluctuates significantly or is close to zero, revenue or gross profit may be more appropriate. For a not-for-profit entity, total revenue or total expenses is typically more meaningful than a profit measure.

This is the first judgment the auditor documents, and it is the judgment most often questioned at inspection. The AFM has noted in its inspection findings that auditors sometimes select a benchmark without documenting why that benchmark is appropriate for the specific entity. Copying last year's benchmark without reassessing whether it remains appropriate is a distinct finding category.

Benchmark options by entity type

ISA 320.A4 through A7 provide guidance on benchmark selection for different entity types. The materiality calculator maps these to 13 industry presets.

Commercial entities (profit-oriented, stable earnings). Profit before tax from continuing operations is the default starting point under ISA 320.A4. "Continuing operations" matters. If the entity has discontinued operations or significant one-off items, the benchmark should exclude these to avoid distortion. When profit before tax is abnormally high or low relative to the entity's normal trading pattern, consider using a normalised or averaged profit figure over two to three years.

Revenue-driven entities (volatile or minimal profit). Total revenue is the appropriate benchmark when the entity operates on thin margins, reports losses, or has profit that swings between years. This applies to many mid-sized service companies, early-stage entities, and entities in cyclical industries. Revenue is typically the most stable measure of scale for these entities. ISA 320.A4 supports revenue as a benchmark when profit is not a reliable indicator of entity size.

Financial institutions. Net asset value or total equity is often the primary benchmark because users of financial institution statements focus on the balance sheet. Total assets may also be appropriate. Profit before tax can serve as a secondary benchmark, but the balance sheet measures typically drive materiality because credit risk, capital adequacy, and solvency are the primary concerns of regulators and depositors.

Not-for-profit entities. Total revenue or total expenses serves as the benchmark under ISA 320.A5. Profit is not a meaningful measure because these entities do not operate for profit. Total expenses may be more appropriate when the entity's activities are primarily cost-driven (a social housing provider, a charity delivering services). Total revenue may be more appropriate when the entity receives significant grant income and users focus on how much was received.

Public sector entities. Total expenditure or total appropriations is typically the benchmark. ISA 320.A5 acknowledges that the needs of users in the public sector may differ from those of users of commercial entity statements. The benchmark should reflect the measure that legislators and oversight bodies would consider significant. In many European jurisdictions, materiality for public sector audits is set by the supreme audit institution or guided by sector-specific practice notes.

Percentage ranges: what ISA 320.A3-A7 actually says

ISA 320.A3 states that determining materiality involves the exercise of professional judgment and that a percentage is often applied to a chosen benchmark as a starting point. The standard does not prescribe specific percentages. Practice, supported by firm methodology manuals and inspection expectations, has established accepted ranges.

For profit before tax, the commonly applied range is 5% to 10%. The lower end applies to listed entities or entities with higher inherent risk. The upper end applies to smaller owner-managed entities where users have direct access to management and other sources of information. Most mid-market European audits land between 5% and 7.5%.

For revenue, the range is typically 0.5% to 2%. Revenue is a larger absolute number than profit, so the percentage is correspondingly lower. The lower end (0.5% to 1%) applies to larger entities or entities in regulated industries. The upper end (1% to 2%) applies to smaller entities.

For total assets, the range is 0.5% to 2%, similar to revenue. This is the typical range for financial institutions and entities where the balance sheet is the primary focus.

For total equity or net asset value, the range is 1% to 5%. The wider range reflects the variability of equity as a measure across different entity types.

For total expenses (not-for-profit and public sector), the range is 0.5% to 2%, mirroring the revenue range because the absolute numbers are similar in scale.

These ranges are starting points. The percentage selected within the range must be justified by reference to the entity's specific circumstances, not applied mechanically.

A practical consideration: the percentage and the benchmark interact. Selecting profit before tax at 7.5% for an entity with €2M profit produces €150,000. Selecting revenue at 1% for the same entity (with €40M revenue) produces €400,000. The choice of benchmark is not neutral. It drives the materiality figure, the performance materiality, the sample sizes, and the tolerable misstatement for every substantive test. When two benchmarks produce materially different results, the auditor should document why the selected benchmark and its resulting figure are appropriate, not just note that both were considered.

Some firms apply a cross-check: calculate materiality using the primary benchmark, then calculate it using an alternative benchmark, and if the results diverge by more than 50%, explain the divergence. This is not an ISA requirement, but it is good practice and provides the reviewer with evidence that the auditor considered the sensitivity of the determination to the benchmark choice.

Industry-specific considerations

The benchmark and percentage are only the first two inputs. ISA 320.A3 requires the auditor to consider qualitative factors that may affect the selection.

Manufacturing entities. Revenue is often the most stable benchmark because profit in manufacturing fluctuates with raw material costs and foreign exchange movements. If the manufacturer is profitable and earnings are stable, profit before tax works. If margins are thin (below 3% to 5%), revenue at 0.5% to 1% typically produces a more appropriate figure. The auditor should also consider whether the entity has significant inventory, which drives balance sheet risk and may warrant a lower materiality to ensure adequate testing of inventory valuations.

Financial services. Total assets at 0.5% to 1% or net asset value at 1% to 2% is standard. The key consideration is regulatory capital. If materiality set at 1% of total assets exceeds a level that could affect the entity's regulatory capital position, the auditor must consider whether a lower materiality is needed. Users of financial institution statements (regulators, depositors) have lower tolerance for misstatement than users of a typical commercial entity's statements.

Not-for-profit. Total expenses at 0.5% to 2%. The critical qualitative factor is donor sensitivity. A €50,000 misstatement in a charity with €10M of expenses might be immaterial by percentage (0.5%), but if it relates to restricted funds or donor-specified programmes, qualitative considerations may require a lower materiality. The auditor should also consider whether the entity is subject to regulatory reporting thresholds that function as de facto materiality limits.

For entities receiving government grants with specific reporting requirements, the grant conditions may impose a threshold below which misstatements must still be reported to the grantor. If the grant agreement requires reporting all variances exceeding €10,000, the auditor's materiality of €50,000 creates a gap. Specific materiality (ISA 320.10) for the grant-funded accounts should be set at or below the reporting threshold to ensure the audit detects misstatements the grantor cares about.

Public sector. Total expenditure at 0.5% to 2%. Political sensitivity drives the qualitative adjustment. Public scrutiny of government spending means that misstatements well below the calculated materiality level could be material by nature. Amounts involving elected officials, compensation disclosures, or compliance with appropriation limits may require specific materiality thresholds separate from overall materiality. Many European supreme audit institutions publish sector-specific guidance that supplements ISA 320.

Qualitative adjustments: when and how much

ISA 320.A3 identifies several factors the auditor considers when selecting a benchmark and determining the percentage. These function as qualitative adjustments to the mathematically calculated starting point.

The adjustment is always downward. The calculated materiality is a ceiling, not a floor. If qualitative factors indicate that users have a lower tolerance for misstatement, the auditor reduces the figure. There is no qualitative basis for increasing materiality above the calculated amount.

Factors that warrant a downward adjustment include: the entity is listed or publicly visible, the entity is close to a debt covenant threshold where a misstatement could trigger a breach, the entity is in a regulated industry with reporting thresholds, users are known to focus on specific line items (revenue for a startup seeking investment, cash for a distressed entity), or the entity has a history of misstatements that have required adjustment. ISA 320.A8 also notes that the auditor may identify information that would have caused a different determination had it been known at planning, requiring revision at completion.

How much to adjust is a matter of judgment, but the documentation must state why the adjustment was made and how the revised figure relates to the unadjusted calculation. A common approach is to state: "Calculated materiality based on [benchmark] at [percentage] = [amount]. Reduced by [X]% to [amount] due to [specific factor]." The specific factor must be named, not described as "general risk" or "professional judgment."

Adjustments of 10% to 25% are common for entities with one or two qualitative factors. Adjustments exceeding 25% should be supported by specific evidence (a covenant threshold within striking distance, a known regulator investigation, a pending listing). An adjustment that reduces materiality by more than 50% effectively changes the benchmark. At that point, the auditor should consider whether a different benchmark altogether would be more appropriate than a heavily adjusted figure from the original benchmark.

One area where qualitative adjustments are frequently insufficient is entities approaching insolvency. When going concern is in doubt, users of the financial statements (particularly lenders and trade creditors) have a much lower tolerance for misstatement. Materiality set at 5% of profit before tax for an entity that may not survive the next twelve months does not reflect the decisions those users are making. The auditor should consider whether a balance sheet measure (net assets, total liabilities) is a more appropriate benchmark for an entity in financial difficulty.

Worked example: four entities, four benchmarks

Scenario: An audit firm in the Netherlands has four clients with December 2025 year-ends. Each requires materiality to be determined at the planning stage.

Entity 1: Dekker Machining B.V., a precision manufacturing company. Revenue €42M. Profit before tax €2.8M. Margins have been stable between 5% and 8% over the past four years. Not listed. One bank lender with a debt covenant requiring net equity above €5M (current equity: €11M).

1. Select benchmark. Profit before tax is appropriate because earnings are stable and the entity is profit-oriented. Revenue is an alternative, but with margins above 5%, profit before tax better reflects the entity's economic substance for users. Documentation note: Record the benchmark selection as profit before tax with the rationale that earnings are stable and the entity is profit-oriented. Note that revenue was considered but rejected because stable margins make PBT a more precise measure.

2. Apply percentage. At the lower end of the range: 5% of €2.8M = €140,000. At the upper end: 7.5% of €2.8M = €210,000. The entity is not listed, reducing the need for the lower end. However, the bank covenant exists. Selected: 5% = €140,000. Documentation note: Record the percentage as 5%, producing €140,000. Note the covenant as a factor supporting the lower end of the range.

3. Qualitative adjustment. The debt covenant threshold of €5M net equity is comfortable (current equity €11M, headroom of €6M). No adjustment needed. If equity were closer to €5M, a further reduction would apply. Documentation note: Record that the covenant headroom was assessed and no qualitative adjustment is required.

Entity 2: Rijnmond Banking N.V., a regional bank. Total assets €620M. Net equity €48M. Profit before tax €5.2M.

4. Select benchmark. Total assets at 0.5% = €3.1M. Net equity at 2% = €960,000. The bank is regulated by DNB. Users (depositors, regulators) focus on the balance sheet. Net equity is selected because it is closer to the regulatory capital measure. Documentation note: Record that total assets and net equity were both considered. Net equity selected because regulatory capital adequacy is the primary user concern.

5. Apply percentage and adjust. 2% of €48M = €960,000. DNB regulatory reporting thresholds apply. No specific threshold is breached, but the auditor reduces to 1.5% = €720,000 to reflect the regulated environment. Documentation note: Record the 1.5% percentage with the regulatory environment as the qualitative factor driving the reduction from the 2% starting point.

Entity 3: Stichting Woonzorg, a social housing association. Total expenses €28M. No profit measure (not-for-profit). Government-funded.

6. Select benchmark and apply percentage. Total expenses at 1% = €280,000. The entity is subject to the Woningwet (Housing Act) and reports to the Authority for Housing Corporations (Aw). Donor sensitivity is low (government-funded), but regulatory reporting requirements exist. Selected: 1% = €280,000. Documentation note: Record total expenses as the benchmark because the entity is not-for-profit and primarily cost-driven. 1% selected, reflecting the regulatory reporting requirements under the Woningwet.

Entity 4: Gemeente Waterstad, a mid-sized Dutch municipality. Total expenditure €95M.

7. Select benchmark and apply percentage. Total expenditure at 1% = €950,000. Political sensitivity is high. Council expenditure is publicly scrutinised. The Audit Committee has previously raised concerns about amounts exceeding €500,000. Reduce to 0.75% = €712,500. Documentation note: Record total expenditure at 0.75%, reduced from the 1% starting point due to the Audit Committee's stated sensitivity threshold and public scrutiny of council expenditure.

Practical checklist

1. Identify the entity type (commercial, financial institution, not-for-profit, public sector) and select the benchmark from ISA 320.A4-A5 that users of the financial statements would regard as most significant. Document the benchmark selection with a rationale specific to this entity.
2. Select a percentage within the accepted range for the chosen benchmark. Document why the selected point within the range is appropriate (entity size, risk profile, regulatory environment, listing status).
3. Calculate the resulting figure and assess it against any known regulatory thresholds, covenant limits, or user sensitivity factors. If a qualitative adjustment is needed, state the factor, the direction (always downward), and the resulting figure.
4. Set performance materiality as a percentage of overall materiality (typically 50% to 75% under ISA 320.11), with the percentage driven by the auditor's assessment of the risk of aggregate uncorrected misstatements exceeding overall materiality.
5. Reassess materiality at the completion stage under ISA 320.12-13. If the final financial figures differ materially from the planning-stage figures used to calculate materiality, recalculate and assess whether additional procedures are needed.
6. Use the materiality calculator to verify your calculation against the 13 industry presets and confirm the selected benchmark and percentage fall within accepted ranges.

Common mistakes

• Using revenue as the benchmark for a profitable entity with stable earnings without documenting why profit before tax was rejected. The AFM specifically looks for evidence that the auditor considered the default benchmark before selecting an alternative.
• Applying the same percentage year after year without reassessing whether the entity's circumstances have changed. An entity that was highly profitable last year but is now loss-making may need a different benchmark entirely, not just a different percentage.
• Setting materiality at the planning stage and never revising it at completion. ISA 320.12 requires the auditor to revise materiality if information becomes available during the audit that would have caused a different determination. The FRC's inspection findings confirm this is one of the most common ISA 320 deficiencies.

Related content

• Materiality glossary entry. Defines overall materiality, performance materiality, and specific materiality with references to ISA 320 paragraph numbers and worked examples.
• Materiality calculator. The free tool with 13 industry presets referenced throughout this post. Automates benchmark selection and percentage ranges, with built-in performance materiality calculation.
• Component materiality in group audits: ISA 600 allocation methods. Covers how overall materiality set at group level is allocated to components, building directly on the ISA 320 benchmark selection explained here.