ISA 320

Materiality in Planning and Performing an Audit

1Objective and scope

ISA 320 deals with the auditor's responsibility to apply the concept of materiality in planning and performing an audit of financial statements. ISA 450 explains how materiality is applied in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements on the financial statements. Financial reporting frameworks discuss materiality in the context of preparing and presenting the statements; the auditor's determination of materiality is a matter of professional judgement, affected by the auditor's perception of the financial information needs of users as a group, assuming they have reasonable knowledge of business and accounting, understand that statements are prepared and audited to levels of materiality, recognise inherent uncertainties in estimates, and make reasonable economic decisions on the basis of the statements.

The objective is to apply the concept of materiality appropriately in planning and performing the audit. Materiality and audit risk are considered throughout, in identifying and assessing risks, in determining the nature, timing and extent of further procedures, and in evaluating the effect of uncorrected misstatements and forming the opinion.

2Key definitions

3Requirements

Determining materiality when planning

• When establishing the overall audit strategy, determine materiality for the financial statements as a whole. Where, in the specific circumstances of the entity, there are one or more particular classes of transactions, balances or disclosures for which misstatements of lesser amounts could reasonably be expected to influence users, determine the materiality level or levels to apply to them.
• Determine performance materiality for purposes of assessing the risks of material misstatement and determining the nature, timing and extent of further audit procedures.
• Benchmark selection considers the elements of the financial statements, whether there are items on which users' attention tends to focus, the nature of the entity, its life cycle, industry and economic environment, its ownership structure and financing (a lender may focus on assets, an investor on profit), and the volatility of the benchmark. A normalised profit may be used when the current year's is unusually high or low, and total revenue or assets when the entity is loss-making or not-for-profit.

Revision as the audit progresses

The auditor revises materiality for the financial statements as a whole (and any specific materiality) if the auditor becomes aware of information during the audit that would have caused a different amount to be determined initially: a change in circumstances (a disposal of a major part of the business), new information, or a change in the auditor's understanding of the entity (the actual results differ substantially from the anticipated results used to set the benchmark). If materiality is lowered, the auditor determines whether performance materiality also needs revising and whether the nature, timing and extent of further audit procedures remain appropriate; work already performed at a higher threshold may need extending.

4Documentation and reporting

The audit documentation includes the amounts and the factors considered in determining materiality for the financial statements as a whole, materiality for particular classes of transactions, balances or disclosures where applicable, performance materiality, and any revision of these as the audit progressed, with the reasons. The concept of materiality applied in planning and executing the audit is communicated to those charged with governance under ISA 260 as part of the planned scope, without necessarily disclosing the amounts, and the auditor's report describes materiality in general terms in the 'Auditor's responsibilities' section. For listed entities in some jurisdictions the report discloses the materiality figure; the ISAs do not require it, and Kenya does not.

5Examinable focus