Audit Materiality (SA 320): How Auditors Actually Set the Number
- Auditors set audit materiality as a rupee threshold — typically 0.5%–2% of revenue or 1%–5% of profit before tax — below which errors are ignored; SA 320 governs this judgment in India.
- The materiality number is not fixed by law; it is a professional judgment call made at the planning stage and revised if facts change during the audit.
- Misstatements above the materiality threshold must be corrected or reported; those below are accumulated to check whether their combined effect still matters.
- What SA 320 Actually Says (In Plain English)
- How Auditors Actually Choose the Benchmark and the Percentage
- Worked Example: Setting Materiality for a Mid-Size Manufacturing Firm
- Performance Materiality: The Number That Actually Drives Day-to-Day Testing
- When Materiality Gets Revised Mid-Audit
- Qualitative Materiality: When ₹1 Can Be Material
- Common Mistakes — Both by Auditors and by Business Owners
- What This Means for You as a Business Owner
Audit materiality is the rupee cut-off that decides which errors an auditor must chase and which ones can be safely ignored. Under SA 320 – Materiality in Planning and Performing an Audit, issued by the Institute of Chartered Accountants of India (ICAI), every statutory auditor must fix this number before fieldwork begins. Get it wrong — set it too high and real fraud slips through; set it too low and the audit becomes an endless, expensive exercise. This article explains exactly how auditors arrive at that number, using plain arithmetic and real rupee figures, so you know what your auditor is actually doing when they walk into your office.
What SA 320 Actually Says (In Plain English)
SA 320 says that information is material if its omission or misstatement could reasonably influence the economic decisions of users of the financial statements. Notice three things:
- It is about the user's decision, not the auditor's comfort.
- The word "reasonably" means a typical, informed user — not the most cynical reader or the most gullible one.
- Materiality is always entity-specific. A ₹5 lakh error is trivial for a ₹500 crore company but catastrophic for a ₹30 lakh proprietorship.
SA 320 also introduces a companion concept: performance materiality. This is a lower working threshold — usually 50%–75% of overall materiality — used during fieldwork so that the accumulation of many small undetected errors does not silently breach the overall threshold.
How Auditors Actually Choose the Benchmark and the Percentage
Step 1 is picking the right financial benchmark. The auditor looks at the nature of the entity and what its users care about most.
| Type of Entity | Common Benchmark | Typical Percentage Range |
|---|---|---|
| Profit-making company (stable profits) | Profit Before Tax (PBT) | 5% – 10% of PBT |
| Low-margin or loss-making company | Total Revenue / Turnover | 0.5% – 2% of Revenue |
| Non-profit / NGO | Total Expenditure | 0.5% – 2% of Expenditure |
| Asset-heavy entity (real estate, infrastructure) | Total Assets | 0.5% – 1% of Total Assets |
| Holding / investment company | Net Assets / Equity | 1% – 2% of Net Assets |
Step 2 is applying professional judgment to adjust within that range. A highly regulated industry (banking, insurance) warrants a lower percentage. A simple trading business with few transactions might allow a higher one.
Worked Example: Setting Materiality for a Mid-Size Manufacturing Firm
Let us say your company, Sharma Auto Parts Pvt. Ltd., has the following figures for FY 2026-27:
- Total Revenue: ₹8,40,00,000 (₹8.4 crore)
- Profit Before Tax: ₹72,00,000 (₹72 lakh)
- Total Assets: ₹5,20,00,000 (₹5.2 crore)
The auditor decides PBT is the most relevant benchmark because the company is consistently profitable and its lenders focus on earnings. She applies 7% of PBT:
Overall Materiality = ₹72,00,000 × 7% = ₹5,04,000
She then sets Performance Materiality at 65% of Overall Materiality:
Performance Materiality = ₹5,04,000 × 65% = ₹3,27,600
Finally, she sets a Clearly Trivial threshold at 5% of Overall Materiality:
Clearly Trivial = ₹5,04,000 × 5% = ₹25,200
In practice this means: errors below ₹25,200 are not even recorded in the audit file. Errors between ₹25,200 and ₹3,27,600 are logged and accumulated. If their total crosses ₹3,27,600, the auditor investigates further. Any single error above ₹5,04,000 must be corrected or disclosed — no exceptions.
Performance Materiality: The Number That Actually Drives Day-to-Day Testing
Many business owners are surprised when auditors test transactions that seem very small. The reason is performance materiality. Auditors design their sample sizes and testing thresholds using the lower number (₹3,27,600 in our example), not the headline figure. This buffer absorbs the risk that several undetected misstatements together could exceed overall materiality. SA 320 makes this two-level approach mandatory — the auditor cannot simply work to one number throughout.
When Materiality Gets Revised Mid-Audit
SA 320 requires the auditor to revise materiality if new information emerges during fieldwork that would have led to a different figure at the planning stage. Common triggers include:
- Discovering that the draft PBT was overstated — the actual PBT is significantly lower, making the original threshold too generous.
- A change in the entity's risk profile (e.g., a major customer default discovered during the audit).
- Finding that one segment of the business is far more significant than previously understood.
Revision almost always means the threshold goes down, not up, because the auditor needs more comfort, not less, once unexpected issues surface.
Qualitative Materiality: When ₹1 Can Be Material
SA 320 does not let auditors hide behind pure arithmetic. Certain misstatements are material regardless of their rupee amount because of their nature:
- A director's undisclosed related-party loan of ₹80,000 — below any threshold but legally significant.
- A regulatory breach (say, a violation of Companies Act provisions on inter-corporate loans) stated incorrectly in the notes.
- Fraud by a senior employee, regardless of the amount stolen.
- Misclassification that changes a profit into a loss or vice versa.
The auditor must always weigh qualitative factors alongside the rupee threshold. This is why SA 320 calls materiality a matter of professional judgment, not a mechanical formula.
Common Mistakes — Both by Auditors and by Business Owners
- Using last year's materiality without recalculation. Businesses grow, shrink, or change in nature. An auditor who simply rolls forward the prior-year figure without fresh analysis is violating the spirit of SA 320 and potentially missing material errors.
- Treating performance materiality as optional. Some smaller audit firms skip performance materiality and test everything to the overall threshold. This is non-compliant with SA 320 and inflates the risk of undetected accumulated errors.
- Business owners hiding "small" adjusting entries. A common mistake is assuming that because an entry is below what you think is the materiality limit, the auditor will not ask about it. Auditors accumulate all unadjusted differences — ten ₹2 lakh entries can equal one ₹20 lakh problem.
- Ignoring qualitative factors entirely. Auditors who set a threshold and mechanically ignore everything below it miss the point. A ₹50,000 payment to a related party without board approval may not move the needle arithmetically but is qualitatively significant.
- Confusing tax audit materiality with statutory audit materiality. In a tax audit under Section 44AB, the auditor is verifying specific figures required by the Income Tax Act. There is no SA 320-style materiality concept in tax audits — every number in Form 3CD must be accurate. If your statutory auditor handles your tax audit too, make sure you understand the difference. Our Tax Audit Services team can walk you through what each engagement covers.
What This Means for You as a Business Owner
Understanding audit materiality helps you have more productive conversations with your auditor. When your auditor flags an error, ask them where it sits relative to their materiality and performance materiality thresholds. If they want to pass on a ₹4 lakh difference in a ₹8.4 crore company, ask them to show you the accumulation schedule — you deserve to see whether smaller uncorrected items are adding up to a number that matters. Equally, if your auditor is spending days on ₹15,000 entries, ask whether those fall above the clearly trivial threshold and why. SA 320 gives both sides — auditor and client — a rational framework for these discussions.
Do it yourself in minutes — free to try, no login needed.
Open Tax Audit Services →Frequently asked questions
Is audit materiality the same every year for my company?
No. The auditor recalculates materiality every year based on current-year figures. If your profit or revenue changes significantly, the rupee threshold changes too. Rolling forward last year's number without recalculation is a SA 320 violation.
Can my auditor ignore a ₹5 lakh error if materiality is set at ₹8 lakh?
Not automatically. The auditor must accumulate all unadjusted differences. If several smaller items together exceed performance materiality (typically 50–75% of overall materiality), the auditor must investigate further. A single ₹5 lakh item may also be qualitatively material depending on its nature.
Does SA 320 apply to tax audits under Section 44AB?
No. SA 320 is a Standard on Auditing that applies to statutory audits under the Companies Act and similar engagements. A tax audit under Section 44AB of the Income Tax Act is a separate exercise where the auditor must verify and report specific figures accurately — there is no materiality threshold that allows figures to be rounded or omitted.
Who decides the materiality number — the auditor or the client?
The auditor decides, independently. The client has no right to set or override the materiality threshold. However, a good auditor will explain the basis for their threshold and discuss it with management — especially if the auditor later proposes to pass on (not correct) certain differences above the clearly trivial level.
General information for FY 2026-27, not professional advice for your specific case. Rules change — verify against the latest notification or ask a KyaTax expert.
Related: All free tools · More guides · Virtual CFO