How to Calculate and Document Materiality Under ISA 320

Most firms set materiality once at planning and never revisit it, even when revenue falls 30% mid-year. Setting the number is not the hard part. You pick a benchmark, apply a percentage, get a figure. Fifteen minutes. The hard part is what almost nobody does: writing down why you picked that percentage instead of a different one, then going back to check the number at completion when actual results come in. The FRC’s materiality thematic review found that all or the majority of audits at some firms defaulted to the highest permissible performance materiality (PM) under the firm’s internal guidance, with no explanation for why. On maybe three out of five files we review, the gap is the same. The number is there. The rationale is not.

Every year-end meeting has the same awkward moment: someone notices PM is unchanged from last year, and no-one wants to be the one to ask why. At that point the file has already been through planning review, and the partner signed off a methodology memo that cites the risk assessment. Questioning PM now means questioning the methodology. So nobody does. We call this “SALY with a methodology shield”: roll the PY percentage forward, cite the risk assessment, move on. It works until the regulator pulls the file.

Choosing a benchmark and documenting the reasoning

Choosing a benchmark is not about finding the “correct” metric. There isn’t one. It’s about picking the metric that your entity’s users care about most and documenting why. ISA 320.A4 gives you the factors: nature of the entity, what users focus on, and volatility of the measure. For a profit-oriented entity, you’ll usually land on PBT. For a not-for-profit, total revenue or total expenditure. For an asset-heavy entity like an investment property company, total assets.

That much is straightforward. The problem is what happens next.

ISA 320.10 says the auditor exercises professional judgment to select a benchmark and percentage that produces a meaningful materiality level. What actually happens: most firms have methodology documents that give ranges (3–10% of PBT, 0.5–2% of revenue) and most teams just SALY the PY percentage or pick the top end. We’ve reviewed files where the mat WP contains nothing beyond the number. No benchmark justification. No rationale. Just “5% of PBT = EUR X.”

The FRC writes “no evidence that judgment had been exercised.” What that means in practice: the team used the default in the methodology and moved on. ISA 320.14 requires documentation of materiality, the factors considered, and any revisions. One paragraph connecting the percentage to the entity’s characteristics is enough. It takes 10 minutes. It’s the difference between a clean file and a finding.

When the benchmark is volatile or abnormal

When PBT is volatile, unusually high, unusually low, or negative, you need to go beyond the firm’s default ranges. Options include normalising PBT over several years, switching to revenue or total assets, using multiple benchmarks and selecting the most appropriate, or blending a normalised profit with a revenue cross-check. If you’ve used our materiality calculator, you’ll recognise these options. The calculator runs the arithmetic. What it can’t do is pick the right benchmark for your entity. That’s your job, and you need to document why you chose it.

Performance materiality: where most files fall short

PM is not conceptually harder than overall mat. But it’s where documentation is weakest and inspector scrutiny is highest. This is the section most teams get wrong.

Performance materiality is not a second materiality figure. It’s a working threshold. You test to PM throughout fieldwork so that the aggregate of uncorrected and undetected misstatements stays below overall mat when you form the opinion. Think of overall mat as the line for the opinion and PM as the line for your procedures.

Why PM exists

If you designed all procedures to detect only individually material misstatements, you’d miss the aggregation risk. Multiple smaller misstatements, each individually fine, adding up to a material amount. Sampling also leaves some possibility of undetected misstatements. PM builds in a margin for both. It’s not complicated. It’s just a buffer.

How to set it (and why most teams don’t do this properly)

ISA 320.A12 says the determination is not a simple mechanical calculation. The standard provides no preset formula. Factors include your understanding of the entity (particularly from PY experience) and your expectations about misstatements in the current period.

In practice, PM is set at 50–75% of overall mat:

• 60–75% where prior-year experience indicates few misstatements and good controls
• 50–60% where prior-year experience indicates numerous misstatements, weak controls, or first-year engagements where you lack history

In our experience, PM sits at 75% on maybe four out of five files we review. No documented reason for choosing 75% over 60%. The WP says “75% of overall materiality” and nothing else. No reference to PY misstatements. No mention of control effectiveness. The phrase that comes up in review meetings is “just roll it forward.” The FRC found the same thing: “all or the majority of audits defaulted to the highest permissible PM under the firm’s internal guidance, consistent with a general lack of explanations.” That’s their language. Ours is simpler: nobody documented why.

This matters because PM drives scope. Higher PM means smaller samples, narrower testing, less work. So when a reviewer sees 75% with no rationale, the question writes itself: did the team choose 75% because the risk profile justified it, or because it produced less work? Honestly, we all know which one it usually is.

As we covered in our ISA 315 risk assessment guide, the risk identification process feeds directly into where you set PM. If you assessed risks as higher in ISA 315 but then set PM at 75%, you have a consistency problem. The file tells two different stories.

Look, the standard is genuinely ambiguous on how to determine PM. ISA 320.A12 acknowledges this by saying it involves judgment rather than prescribing a formula. That ambiguity is not an excuse for skipping the documentation. It’s the reason the documentation matters more. One sentence linking your PM percentage to the PY error rate and control effectiveness. That’s it. Just SALY-ing the PY percentage without checking whether it still makes sense is exactly the kind of thing that generates RNs.

Specific materiality and the clearly trivial threshold

ISA 320.10 recognises that for certain classes of transactions, account balances, or disclosures, misstatements of lower amounts could influence users’ decisions. Common examples: related party transactions, key management compensation, regulatory capital for financial institutions, revenue where it’s a key performance metric under market scrutiny.

Where you set specific materiality for particular items, you also need a corresponding specific PM.

The “clearly trivial” threshold is technically ISA 450 rather than ISA 320, but it’s operationally linked. You designate an amount below which misstatements don’t get accumulated. ISA 450.A2 is clear that “clearly trivial” is a wholly different (smaller) order of magnitude than materiality, not just “not material.” In practice, firms set this at 3–5% of overall materiality, sometimes up to 10%.

We’re oversimplifying the specific materiality question here. In reality, it requires a separate assessment for each class of transactions or balance where lower materiality applies. For now, the key point: if your entity has related party transactions, key management compensation, or regulatory capital requirements, you need to consider whether overall materiality is the right threshold for those items. Usually it isn’t.

When to revisit materiality at completion

ISA 320.12–13 requires revision if you become aware during the audit of information that would have caused a different initial determination.

This is where most files fail.

Two triggers come up the most. Actual results differ significantly from planning estimates (profit came in much higher or lower than budgeted), or a significant event changes the entity’s financial position (disposal of a division, major litigation settlement). A third comes up occasionally: your understanding of the entity’s risks changed materially during fieldwork.

The most common RN we write on mat is: “Where is the rationale for not revisiting materiality at completion when actual results differ from planning estimates by more than 15%?” Teams plan mat in November based on draft management accounts. By March, actual results are in. If PBT moved by 20%, the calculation should be revisited. Not necessarily changed. Revisited, with documented reasoning. You can conclude the original figure is still appropriate. You just can’t conclude that silently.

When mat is revised downward late in the audit, you also need to consider whether PM and the scope of your procedures remain appropriate (ISA 320.13). A downward revision may require additional sub testing. That’s painful at completion, especially when the EP wants to sign and the client is chasing the report. But the alternative is an inspection finding, and those are more painful.

This completion step takes 15 minutes on a recurring engagement if you build it into your workflow. Most teams skip it because nobody prompted them. Not because it’s hard. Wash, rinse, repeat. The AFM and the FRC both flag it every cycle. Nothing changes because firms treat mat as a planning-stage exercise. It isn’t.

Qualitative considerations

Qualitative materiality is not about lowering the number. It’s about recognising that some misstatements matter regardless of size. ISA 320.6 says the mat determined at planning does not establish a mechanical threshold below which everything is immaterial. Misstatements affecting loan covenants. Misstatements that turn a profit into a loss. Anything related to fraud, even EUR 500. Anything arising from management override.

The standard’s guidance on qualitative factors (ISA 320.A3) is, honestly, too vague to apply without firm-level methodology. I’ve seen teams interpret it as “think about whether anything else could be material” and leave it at that. If your firm hasn’t given you a specific list of qualitative triggers, you’re guessing. We recommend documenting at least four factors in every mat WP: regulatory sensitivity, covenant proximity, user expectations about specific metrics, and any known fraud risk factors from the ISA 240 assessment. Whether any are present or not, documenting that you considered them is what the file needs to show.

Worked example: Bakker Industrial B.V.

Step 1: Select the benchmark.
PBT is stable and meaningful. Revenue has been consistent at EUR 26–30M over the past four years. PBT is the appropriate benchmark for a profit-oriented manufacturing entity whose users (the bank and minority shareholders) focus on profitability.

Documentation note: “PBT selected as benchmark per ISA 320.A4. Entity is profit-oriented, profits stable over 4 years, users focus on profitability. Revenue considered as cross-check.”

Step 2: Apply the percentage.
5% of EUR 1.4M = EUR 70,000. But the team needs to justify 5% specifically. Prior-year materiality was EUR 65,000 (5% of EUR 1.3M PBT). The AFM has inspected two files in this firm in the past 18 months. Given the current inspection environment, the team selects 5% rather than moving to the upper end of the range.

Documentation note: “5% applied. Justified by: stable entity, recurring engagement, consistent prior-year experience, current AFM inspection activity. Cross-check against 1% of revenue (EUR 280K) confirms PBT-based materiality is the more conservative measure.”

Step 3: Set PM.
Prior-year audit identified three misstatements totalling EUR 18,000 (all corrected). Controls over revenue and purchasing are tested and effective. PM set at 70% of overall materiality: EUR 49,000.

Documentation note: “PM set at 70% of overall materiality. Prior-year misstatements were below 30% of materiality and all were corrected. Controls over key assertions tested and effective. 70% is appropriate given the low prior-year error rate.”

Step 4: Set the clearly trivial threshold.
5% of EUR 70,000 = EUR 3,500. Misstatements below this amount will not be accumulated.

The complication

In February, actual PBT comes in at EUR 2.1M (50% higher than the planning estimate of EUR 1.4M). Overall materiality should now be reconsidered. 5% of EUR 2.1M = EUR 105,000.

The team revisits. The increase is driven by a one-time contract that won’t recur. After discussion with the engagement partner, the team decides to increase materiality to EUR 90,000 (approximately 4.3% of actual PBT, below the 5% used at planning) and documents the rationale for not going the full EUR 105,000. PM is revised to EUR 63,000. No additional procedures are needed because all testing was performed to the original (lower) PM of EUR 49,000, which is below the revised PM.

Documentation note: “Materiality revised at completion per ISA 320.12. Actual PBT EUR 2.1M vs. planning estimate EUR 1.4M. Revised materiality EUR 90,000 (4.3% of actual PBT). One-time contract revenue of EUR 0.4M considered; normalised PBT of EUR 1.7M at 5% yields EUR 85,000. Rounded to EUR 90,000 to reflect the additional PBT from ongoing operations. Original testing was performed to PM of EUR 49,000, below revised PM of EUR 63,000, so no additional procedures required.”

Practical checklist for your next engagement

1. Document your benchmark choice and the reasoning, not just the number. ISA 320.14 requires it. One paragraph is enough.
2. Cross-check your chosen benchmark against at least one alternative (revenue if using PBT, PBT if using revenue). Note the cross-check result in the working paper.
3. When setting PM, write down why you chose that percentage. Reference prior-year misstatements and control effectiveness. One sentence linking your PM percentage to the prior-year error rate is enough.
4. Build a completion-stage materiality step into your file template. Compare actual results to planning estimates. If PBT moved more than 15%, revisit the calculation and document your conclusion.
5. List four qualitative factors and state whether they apply. Even if none are present, document that you considered them. ISA 320.A3 is the paragraph.
6. If you’re short on time, this is the one step you can’t skip: the completion-stage revision. It’s the finding that appears most consistently in AFM and FRC inspection reports on materiality.

Common mistakes

• No documented rationale for the percentage. The AFM’s thematic reviews have repeatedly flagged files where the materiality working paper contains the number but not the reasoning. “5% of PBT” is not a rationale. “5% of PBT because the entity is a stable manufacturing company with consistent profits, the bank is the primary user, and the loan covenant provides a buffer of 2x materiality” is a rationale.
• Defaulting to 75% PM without justification. We see this on most files we review. If your prior-year file had adjusted misstatements exceeding 20% of materiality or your controls weren’t tested, 75% is hard to defend. The FRC’s 2017 thematic review on materiality flagged insufficient consideration of factors affecting PM.
• Not revisiting at completion. When actual PBT differs from planning estimates by more than 10–15%, the file needs evidence that the team reconsidered materiality. Not necessarily changed it, but reconsidered it, with documented reasoning. Teams treat materiality as a planning-stage exercise. It isn’t.
• Copying last year’s materiality working paper without updating it. The prior-year file is a starting point, not a template to roll forward with new numbers. When the engagement team changes, the new team inherits the prior team’s judgment without questioning whether the benchmark or PM ratio are still appropriate. Partners see this constantly during review.

Frequently asked questions

How is materiality different from performance materiality?

Overall materiality is the threshold for the audit opinion: above this amount, misstatements could influence users’ decisions. PM is a lower figure used throughout fieldwork. You test to PM so that the aggregate of uncorrected and undetected misstatements stays below overall materiality. Think of overall materiality as the line for the opinion and PM as the line for your procedures.

Can materiality change during the audit?

Yes. ISA 320.12 requires revision if you become aware of information that would have caused a different initial determination. The most common trigger is actual results differing significantly from planning estimates. If PBT moved by more than 10–15%, revisit the calculation and document your reasoning, even if you decide the original figure is still appropriate.

What percentage of PBT should be used?

No single correct answer. ISA 320.A8 gives the example of 5% for a manufacturing entity, but that’s an illustration, not a rule. Most firms provide guidance ranges (typically 3–10% for PBT, 0.5–2% for revenue or assets). The percentage you choose must be documented with entity-specific reasoning. Applying 5% without explaining why 5% is appropriate for this entity is the most common inspection finding on materiality.

Does materiality apply to disclosures?

Yes. Materiality applies to the financial statements as a whole, including disclosures. Misstatements in disclosures (omissions, inaccuracies, obscured information) can be material. ISA 320.A3a addresses qualitative materiality considerations for disclosures. In practice, many teams forget to consider whether disclosure misstatements could independently be material, even if they fall below the quantitative threshold.

What if the entity is loss-making?

PBT may still work as a benchmark, using the absolute amount of the loss. Alternatively, normalise profit over several years, switch to revenue or total assets, or use an average of prior-year profits. The key is that the resulting figure must be meaningful for the entity’s users. Document why you chose the alternative benchmark and why the original was inappropriate.

Further reading and source references

• IAASB Handbook 2024: ISA 320 full text. The authoritative source including all application material.
• ISA 450: Evaluation of Misstatements Identified during the Audit. The companion standard for evaluating misstatements against materiality.
• ISA 315 (Revised 2019): Identifying and Assessing Risks of Material Misstatement. Materiality interacts directly with risk assessment.
• ISA 530: Audit Sampling. PM determines tolerable misstatement for sampling purposes.
• ICAEW: Materiality in the Audit of Financial Statements. A practical guide with worked examples.

This guide reflects the ISA 320 text as published in the IAASB 2024 Handbook. National implementations may include additional requirements. Always consult the applicable national standard alongside the international text. This content is for educational purposes and does not constitute legal or professional advice.

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