ISA 320 — Materiality in Planning and Performing an Audit: Complete Guide

Key Takeaways

ISA 320 requires the auditor to determine materiality for the financial statements as a whole when establishing the overall audit strategy. Misstatements are material if they could reasonably be expected to influence the economic decisions of users.
Materiality is determined using professional judgment — a percentage is typically applied to a chosen benchmark (profit before tax, total revenue, total assets, total expenditure) as a starting point. The choice of benchmark depends on the nature of the entity and what users focus on.
The auditor must also determine performance materiality — one or more amounts set below overall materiality to reduce the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality. Performance materiality drives the actual scope of audit procedures.
For specific classes of transactions, account balances, or disclosures where misstatements of lesser amounts could influence users, the auditor may set a lower materiality level (specific materiality).
Materiality must be revised as the audit progresses if the auditor becomes aware of information that would have changed the initial determination — for example, if actual financial results differ significantly from the estimates used at planning.
ISA 320 requires the auditor to document: materiality for the financial statements as a whole, any specific materiality levels, performance materiality, and any revisions during the audit.
Materiality has both quantitative and qualitative dimensions — some misstatements may be material due to their nature regardless of their size.

What is ISA 320?

ISA 320, titled "Materiality in Planning and Performing an Audit," translates one of the most fundamental concepts in financial reporting into a practical audit tool. The concept is deceptively simple: misstatements matter only if they are big enough to influence the decisions of people who use the financial statements. But determining exactly where that threshold lies — and how it affects the scope and nature of the entire audit — requires significant professional judgment.

ISA 320 operates in tandem with ISA 450 (Evaluation of Misstatements Identified during the Audit). ISA 320 governs the determination of materiality during planning and its revision as the audit progresses. ISA 450 governs the evaluation of misstatements found against materiality when forming the audit opinion.

Materiality in Context

ISA 320.2 anchors the concept in financial reporting frameworks: misstatements, including omissions, are considered 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.

Three critical aspects:

"Individually or in the aggregate" — a single large misstatement is obviously material, but so is an accumulation of smaller misstatements that together exceed the threshold. This is why the auditor needs performance materiality (discussed below).

"Could reasonably be expected to influence" — this is a forward-looking test about what a reasonable user would consider important, not about what has actually influenced anyone.

"Users taken as a group" — the auditor considers the information needs of financial statement users as a group, not of specific individual users whose needs may vary widely.

Determining Materiality for the Financial Statements as a Whole

Choosing a benchmark

ISA 320.A4 identifies factors for selecting an appropriate benchmark:

The nature of the entity — a profit-oriented entity typically uses profit; a not-for-profit may use total revenue or total expenditure; an entity whose balance sheet is the primary focus (such as an investment property company) may use total assets.
Elements of the financial statements that users focus on — what are users most interested in?
The relative volatility of the benchmark — a volatile benchmark (such as profit in an early-stage company) may produce an unstable or inappropriate materiality level.

Common benchmarks and percentage ranges

ISA 320 provides limited specific guidance on percentages, offering only two examples (ISA 320.A8): 5% of profit before tax for a profit-oriented manufacturing entity and 1% of total revenue or total expenditure for a not-for-profit. In practice, the ranges used across the profession are:

Benchmark	Typical Range	When Appropriate
Profit before tax	3–10% (commonly 5%)	Profit-oriented entities with stable, meaningful profits
Total revenue	0.5–2% (commonly 1%)	Entities where users focus on revenue, or where profit is volatile/immaterial
Total assets	0.5–2% (commonly 1%)	Asset-intensive entities, investment companies, financial institutions
Total equity / net assets	1–5% (commonly 2%)	Entities where the balance sheet is the primary focus
Total expenditure	0.5–2% (commonly 1%)	Not-for-profit entities, public sector, charities

The percentage trap

One of the most common regulatory criticisms is that auditors mechanically apply the maximum percentage in their firm's guidance without entity-specific justification. If your firm's policy says "up to 5% of profit before tax," 5% is the ceiling — not the default. The appropriate percentage depends on the entity's circumstances, the nature of its users, and the degree of precision those users expect. For a listed entity with sophisticated investors analysing earnings per share to two decimal places, materiality may need to be at the lower end of the range. For a private company with a single owner-manager, a higher percentage may be appropriate. The key is to document why the specific percentage was chosen, not just what it is.

When the benchmark is volatile or abnormal

Where the primary benchmark (typically profit before tax) is volatile, unusually high, unusually low, or negative, the auditor must exercise additional judgment:

Normalise the benchmark — average profit over several years, or use normalised profit excluding non-recurring items.
Switch to an alternative benchmark — if profit is meaningless (early-stage company, loss-making entity), use revenue, total assets, or gross profit.
Use multiple benchmarks — calculate materiality on several bases and select the most appropriate, documenting the reasoning.

Performance Materiality

ISA 320.11 introduces the concept that is arguably more important in practice than overall materiality: performance materiality.

Performance materiality is set below overall materiality. Its purpose is to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality.

Why is this necessary? If the auditor designed all procedures to detect only individually material misstatements, they would miss the risk that multiple smaller misstatements, each individually immaterial, could aggregate to a material amount. Additionally, sampling and other detection methods always leave some possibility of undetected misstatements. Performance materiality builds in a margin for these factors.

How is performance materiality determined?

ISA 320.A12 states that the determination is not a simple mechanical calculation — it involves professional judgment. Factors include:

The auditor's understanding of the entity — particularly from prior-year experience.
The nature and extent of misstatements identified in previous audits — if prior audits consistently found many misstatements, a lower performance materiality is warranted to increase audit precision.
The auditor's expectations about misstatements in the current period.

In practice, performance materiality is typically set at 50–75% of overall materiality for the financial statements as a whole, though this varies:

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 the auditor lacks history.

Specific Materiality

ISA 320.10 recognises that for certain classes of transactions, account balances, or disclosures, misstatements of amounts lower than overall materiality could reasonably be expected to influence users' decisions.

Examples where specific (lower) materiality may be appropriate:

Related party transactions — users are particularly sensitive to these regardless of amount.
Key management compensation — even small misstatements may be significant to governance oversight.
Regulatory capital — for financial institutions, small misstatements could trigger regulatory consequences.
Revenue — where revenue is a key performance metric under intense market scrutiny.
Tax provisions — where tax compliance is a significant concern.

Where specific materiality is set for particular items, a corresponding specific performance materiality should also be determined.

The "Clearly Trivial" Threshold

While not formally part of ISA 320, the concept of "clearly trivial" from ISA 450 is operationally linked. The auditor typically designates an amount below which misstatements are clearly trivial and need not be accumulated. ISA 450.A2 notes that "clearly trivial" is a wholly different (smaller) order of magnitude than materiality — not just "not material." In practice, clearly trivial is typically set at 3–5% of overall materiality (sometimes up to 10%), though this varies by firm methodology.

Revision During the Audit

ISA 320.12–13 requires the auditor to revise materiality if they become aware during the audit of information that would have caused a different initial determination.

Common triggers for revision:

Actual financial results differ significantly from the estimates used at planning (e.g., profit came in much higher or lower than budgeted).
A significant event occurs during the audit that changes the entity's financial position (disposal of a division, a major litigation settlement).
The auditor's understanding of the entity and its risks changes in a way that affects the appropriate benchmark or percentage.

When materiality is revised, the auditor must also consider whether performance materiality and the nature, timing, and extent of further audit procedures remain appropriate (ISA 320.13). A downward revision of materiality late in the audit may require additional procedures.

Qualitative Considerations

ISA 320.6 makes an important point: the materiality determined at planning does not establish a mechanical threshold below which all misstatements are immaterial. Some misstatements may be material because of their nature, regardless of size:

Misstatements that affect compliance with loan covenants or regulatory requirements.
Misstatements that affect trends — turning a profit into a loss, or reversing the direction of a key metric.
Misstatements related to related party transactions or key management compensation.
Misstatements that involve fraud — even a small fraud has implications beyond its monetary amount.
Misstatements that affect segment reporting used by analysts.
Misstatements that arise from management override or intentional actions.

The qualitative dimension means the auditor cannot reduce materiality to a purely mathematical exercise. Professional judgment about the nature and circumstances of misstatements remains essential throughout the audit.

ISA 320 in Your Jurisdiction

Netherlands. COS 320 follows ISA 320 closely. AFM inspections have specifically addressed materiality determination quality, noting a tendency among some firms to use the upper end of benchmark ranges without sufficient entity-specific justification. The AFM expects to see clear documentation of why a particular benchmark and percentage were selected, and evidence that the auditor considered whether the resulting materiality level is appropriate for the entity's users.

Germany. IDW PS 250 adapts ISA 320 for the German context. German practice typically results in somewhat lower materiality levels than some other jurisdictions, reflecting the conservative tradition of German auditing and the emphasis on creditor protection in the German financial reporting framework. The Prüfungsbericht must include an explanation of the materiality levels applied.

United Kingdom. ISA (UK) 320 is substantively aligned with ISA 320. The FRC published a thematic review on materiality in 2013 and 2017 that identified common deficiencies: insufficient justification for benchmark and percentage choices, failure to set specific materiality where appropriate, and inadequate revision when actual results differed from planning estimates. These findings continue to be relevant.

France. NEP 320 implements ISA 320 within the French statutory framework. French practice traditionally applies a concept of seuil de signification (significance threshold) that predates ISA 320 but is now aligned with it. The H3C's inspections examine whether the materiality determination is appropriately documented and whether the relationship between materiality and the scope of procedures is coherent.

Frequently Asked Questions

How is materiality different from performance materiality?

Materiality for the financial statements as a whole is the amount above which misstatements could influence users' decisions — it drives the audit opinion. Performance materiality is set below this amount to reduce the risk that the aggregate of uncorrected and undetected misstatements exceeds overall materiality — it drives the scope of audit procedures. The auditor works to performance materiality throughout the audit and evaluates results against overall materiality when forming the opinion.

Can materiality change during the audit?

Yes. ISA 320 requires revision if the auditor becomes aware of information that would have changed the initial determination. Common triggers include actual financial results differing significantly from planning estimates, or significant events that change the entity's financial position.

What percentage of profit before tax should be used?

There is no single correct percentage. ISA 320 provides the example of 5% of profit before tax for a manufacturing entity, but this is an illustration, not a rule. The appropriate percentage depends on the entity's circumstances, the nature of its users, and the degree of precision expected. Most firms provide guidance ranges (typically 3–10% for profit, 0.5–2% for revenue or assets), with the specific choice requiring professional judgment and documentation.

Does materiality apply to disclosures?

Yes. Materiality applies to the financial statements as a whole, including disclosures. Misstatements in disclosures — including omissions, inaccuracies, and obscured information — can be material. ISA 320.A3a addresses qualitative materiality considerations for disclosures.

What if the entity is loss-making?

When the entity is loss-making, profit before tax may still be an appropriate benchmark (using the absolute amount of the loss). Alternatively, the auditor may use a normalised profit figure, switch to revenue, total assets, or gross profit as the benchmark, or use an average of prior-year profits. The key is that the resulting materiality level must be meaningful for the entity's users.