What is materiality?
Materiality is the auditor's threshold for significance — the monetary amount that drives how much testing is needed, which accounts deserve attention, and whether identified misstatements require correction or disclosure.
In practice, auditors apply this as a quantitative benchmark (e.g., 5% of PBT) supplemented by qualitative judgement for items like related party transactions or regulatory breaches.
Materiality is not a single number. Auditors set overall materiality for the financial statements as a whole, performance materiality as a lower working threshold for individual tests, and occasionally specific materiality for particular classes of transactions or disclosures where users are especially sensitive (e.g., related party transactions, director remuneration).
Key Points
- Materiality drives the entire audit scope. It determines sample sizes, the threshold for investigating differences, and the level at which misstatements must be reported to management.
- It is based on professional judgement. ISA 320 provides no fixed rules. Common benchmarks include 5% of profit before tax, 1% of total revenue, or 1–2% of total assets.
- Performance materiality is always lower than overall materiality (typically 50–75%), creating a buffer against the aggregate effect of undetected misstatements.
- Materiality can be revised during the audit if circumstances change, but only to a lower amount if the auditor concludes the original threshold was too high.
Why it matters in practice
Getting materiality wrong has cascading consequences. Set it too high and the auditor risks missing material misstatements, an audit failure. Set it too low and the team over-audits, wasting time and resources on immaterial items.
In practice, materiality also drives conversations with management and those charged with governance. Misstatements above the "clearly trivial" threshold (typically 5% of materiality) must be accumulated and communicated to management. Uncorrected misstatements above materiality (individually or in aggregate) lead to a modified audit opinion.
For group audits under ISA 600, the group auditor sets component materiality lower than group materiality. This means getting the group-level number right is even more critical, as it cascades down to every component.
Key standard references
- ISA 320.10: Determining materiality for the financial statements as a whole using an appropriate benchmark.
- ISA 320.11: Determining performance materiality for purposes of assessing risks and designing further audit procedures.
- ISA 320.12: Revision of materiality as the audit progresses if the auditor becomes aware of information that would have caused a different determination.
- ISA 320.14: Specific materiality for particular classes of transactions, account balances, or disclosures.
- ISA 450.5: Accumulating misstatements identified during the audit other than those that are "clearly trivial."
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Frequently asked questions
What is the difference between materiality and performance materiality?
Materiality is the overall threshold for the financial statements as a whole. Performance materiality is set lower (typically 50–75% of overall materiality) to reduce the risk that the aggregate of uncorrected and undetected misstatements exceeds overall materiality. Think of performance materiality as the working threshold the auditor uses during testing.
Can materiality change during the audit?
Yes. ISA 320.12 requires the auditor to revise materiality if they become aware of information that would have caused them to set a different amount initially. Common triggers include unexpected changes in the entity's financial results, a change in the benchmark, or the discovery of significant misstatements.
Is materiality purely quantitative?
No. While materiality is typically set using a quantitative benchmark (e.g., 5% of profit before tax), qualitative factors can make items material regardless of their amount. Related party transactions, regulatory breaches, and management remuneration disclosures are common examples where qualitative materiality applies.