Statutory audit materiality under SA 320 for FY 2025-26: thresholds, performance materiality, and the common judgment errors

Why SA 320 remains the most-litigated judgment in Indian audits

Materiality is the auditor's most fundamental judgment. It determines the scope of testing, the sample sizes, the nature of substantive procedures, and ultimately whether identified misstatements need to be corrected or reported in the audit opinion. SA 320, the Standard on Auditing on Materiality in Planning and Performing an Audit issued by the ICAI's Auditing and Assurance Standards Board, codifies the framework. But the application is judgment-intensive, and the National Financial Reporting Authority (NFRA) inspection reports through FY 2023-24 and FY 2024-25 have repeatedly identified materiality documentation gaps as a leading finding category.

For FY 2025-26 statutory audits, the materiality framework is doubly important. The NFRA expanded inspection coverage now extends to mid-tier audit firms, the SEBI LODR and IND AS framework continues to evolve, and the ICAI's revision of SA 315 (Revised) effective 1 April 2024 has tightened the linkage between risk assessment and performance materiality. The auditor's first 30 days of the FY 2025-26 audit engagement should include a deliberate materiality setting exercise with full documentation.

This post walks through the SA 320 framework, the planning and performance materiality arithmetic, the qualitative factors, the most common judgment errors, and the documentation reset every audit firm should run before NFRA inspection.

Related: Statutory Audit Services · Tax Audit Services · Internal Audit

The SA 320 framework: three threshold concepts

SA 320 prescribes three threshold concepts that the auditor must determine during planning.

Threshold 1: Materiality for the financial statements as a whole (overall materiality). This is the planning materiality, the amount above which a misstatement, individually or in aggregate, could reasonably be expected to influence the economic decisions of users. SA 320 paragraph A4 provides indicative benchmarks: profit before tax, total revenue, gross profit, total expenses, total equity, or total assets, with the selection based on the nature of the entity, the users of the financial statements, and the variability of the chosen benchmark.

Threshold 2: Performance materiality. This is the amount set at less than overall materiality to provide a cushion for uncorrected and undetected misstatements. Performance materiality directly drives the sample sizes for substantive testing under SA 530 (Audit Sampling) and the risk-based testing approach under SA 315 (Revised).

Threshold 3: Clearly trivial threshold. This is the amount below which identified misstatements are clearly inconsequential and need not be accumulated for further evaluation under SA 450. Misstatements at or above this threshold must be tracked, communicated to management, and evaluated in aggregate at the conclusion of the audit.

The three thresholds are nested: clearly trivial < performance materiality < overall materiality.

Setting overall materiality: the benchmark and percentage decision

The benchmark selection is the first judgment. SA 320 paragraph A6 to A7 lists factors:

• Elements of the financial statements (assets, liabilities, equity, income, expenses)
• Whether there are particular items on which users tend to focus
• The nature of the entity, its life cycle, and the industry it operates in
• The entity's ownership structure and capital structure
• The relative volatility of the benchmark

For a profitable Indian listed entity in a mature industry, PBT before exceptional items is the most common benchmark. For loss-making companies or those with volatile profits, total revenue or total assets is preferred. For not-for-profit organisations, total expenses or net assets is used. For start-ups and entities with limited operating history, total assets or net worth is the default.

The percentage selected from the benchmark is typically:

• 5 percent of PBT for stable profitable entities
• 0.5 to 1 percent of total revenue for entities where PBT is unstable
• 1 to 2 percent of total assets for asset-intensive entities
• 1 to 2 percent of net assets for not-for-profits

The auditor must document the benchmark, the percentage, and the rationale in the working papers. NFRA inspections regularly identify auditor files where the benchmark is set but the rationale is not documented or where the rationale is generic boilerplate that does not relate to the specific entity.

Setting performance materiality: the 50 to 75 percent band

Performance materiality is set at less than overall materiality to allow for the aggregate of uncorrected and undetected misstatements. The typical range is 50 to 75 percent of overall materiality.

The decision within this band is driven by:

• The entity's risk profile (higher risk = lower performance materiality)
• The auditor's experience with the client (new client = lower performance materiality)
• The complexity of the entity's transactions (more complex = lower performance materiality)
• The likely volume and nature of misstatements (higher expected misstatements = lower performance materiality)

For a high-risk first-year audit, the auditor may set performance materiality at 50 percent of overall materiality. For a stable continuing client, at 75 percent. The decision must be documented, and the audit team must apply the performance materiality consistently across all substantive procedures.

Component materiality (for group audits under SA 600). Where the entity has multiple components (subsidiaries, divisions), the group auditor must allocate component materiality. SA 600 requires that component materiality be lower than group materiality to allow for aggregation across components. Typical allocation is component materiality = group materiality x (component contribution to group benchmark)^0.5, although various allocation models are used in practice.

Related: Group Audit Coordination · Component Auditor Coordination (SA 600)

Setting the clearly trivial threshold

The clearly trivial threshold is the amount below which misstatements are clearly inconsequential individually and in the aggregate. It is the floor for the audit's accumulation list.

The typical setting is 3 to 5 percent of performance materiality. For an audit with overall materiality of ₹50 lakh and performance materiality of ₹30 lakh (60 percent), the clearly trivial threshold would be approximately ₹1.5 lakh (5 percent of ₹30 lakh).

Misstatements at or above the clearly trivial threshold must be tracked in a Summary of Audit Differences (SAD) or equivalent working paper. The auditor evaluates each misstatement individually for qualitative factors and in aggregate against overall materiality. Items below the clearly trivial threshold can be excluded from the accumulation list.

A common audit working paper failure is the absence of a documented clearly trivial threshold and a SAD that tracks every misstatement, however small. The result is either bloated SADs (where the auditor accumulates immaterial items) or no SAD at all (where the auditor evaluates misstatements ad hoc without accumulation).

Qualitative factors that override the quantitative threshold

SA 320 paragraph 6 and SA 450 paragraph A21 establish that quantitative thresholds are not the sole determinant of materiality. Qualitative factors can elevate an item below the quantitative threshold to a material finding.

Common qualitative factors:

Compliance and regulatory. A misstatement that affects compliance with regulatory requirements (SEBI LODR, RBI directions, SEZ rules, FEMA filings) is material regardless of quantum. The Companies Auditor's Report Order (CARO) 2020 reporting items, even when quantitatively small, must be reported if the underlying compliance is breached.

Debt covenants. A misstatement that, if corrected, would breach a financial covenant (debt-to-equity ratio, interest coverage ratio, net working capital threshold) is material because the consequence (covenant breach, acceleration of debt) is consequential to users.

Trend and direction. A misstatement that turns a loss into a profit, or vice versa, is material even if quantitatively small. Similarly, misstatements that distort the trend of earnings, the year-on-year growth, or key ratios are material.

Related party transactions. Misstatements involving related party transactions (Section 188 of the Companies Act 2013, IND AS 24 disclosures) are material because of the inherent risk of management bias and the user focus on these disclosures.

Management compensation and bonus. Misstatements that affect management compensation, KMP remuneration disclosure under Schedule V of the Companies Act 2013, or bonus computation are material due to user focus.

Fraud and intentional misstatement. Any misstatement that is intentional or fraudulent is material regardless of quantum, under SA 240 (auditor responsibilities relating to fraud).

The auditor must document the qualitative factor evaluation for every misstatement above the clearly trivial threshold, even where the item is corrected by management.

Common judgment errors NFRA surfaces

NFRA inspection reports through FY 2023-24 and FY 2024-25 have surfaced the following recurring materiality-related findings.

Error 1: Generic benchmark documentation. Audit files where the benchmark is set as "5 percent of PBT" with no entity-specific rationale or comparison against alternative benchmarks.

Error 2: Failure to revise materiality. Materiality set at the planning stage but not revised when significant new information emerges during the audit (e.g., an acquisition, a regulatory enforcement, a major lawsuit).

Error 3: Inconsistent performance materiality. Performance materiality set at 75 percent of overall materiality at the planning stage but the substantive procedure sample sizes computed against a different threshold.

Error 4: Missing SAD. No Summary of Audit Differences in the audit file, or a SAD that does not include misstatements above the clearly trivial threshold.

Error 5: Qualitative factor neglect. Quantitative threshold applied mechanically without consideration of qualitative factors, leading to material misstatements being treated as immaterial.

Error 6: Clearly trivial threshold misuse. Auditor sets clearly trivial threshold at a high percentage of performance materiality (e.g., 25 percent), allowing significant misstatements to be excluded from accumulation.

Error 7: Component materiality without rationale. In group audits, allocating component materiality without a documented allocation model or rationale.

The audit documentation reset for FY 2025-26

1. Materiality memo at planning stage. Document the benchmark, percentage, overall materiality computation, performance materiality, and clearly trivial threshold with entity-specific rationale.
2. Risk-link documentation. Link the performance materiality to the risk assessment under SA 315 (Revised). Document how the materiality drives the substantive procedure design.
3. SAD maintenance. Maintain a Summary of Audit Differences from day 1 of the audit. Track every misstatement above the clearly trivial threshold. Evaluate each for qualitative factors.
4. Mid-audit review. Re-evaluate materiality when significant new information emerges. Document the re-evaluation in the working papers.
5. Closing evaluation. At the conclusion of the audit, evaluate the aggregate of uncorrected misstatements against overall materiality. Document the conclusion in the audit completion memo.
6. Qualitative factor checklist. Maintain a checklist of qualitative factors that the engagement team has considered for each misstatement above the clearly trivial threshold.
7. NFRA inspection readiness. Retain the audit file in line with the ICAI 8-year retention rule and the NFRA inspection format expectations.

Talk to KAMRIT

KAMRIT's audit and assurance practice runs statutory audits for over 220 entities across listed, unlisted, NBFC, and not-for-profit segments, with particular focus on SA 320-compliant materiality documentation and NFRA inspection readiness. Our engagement template includes the materiality memo, the SAD framework, the qualitative factor checklist, and the audit completion memo. For audit firms looking to upgrade their materiality documentation or for entities preparing for NFRA inspection coverage, we offer a peer review and process-strengthening engagement starting at ₹1.5 lakh. Reach out at kamrit.in for a free 30-minute methodology review.

References

1. ICAI SA 320, Materiality in Planning and Performing an Audit.
2. ICAI SA 450, Evaluation of Misstatements Identified during the Audit.
3. ICAI SA 315 (Revised), Identifying and Assessing the Risks of Material Misstatement.
4. ICAI SA 530, Audit Sampling.
5. ICAI SA 600, Using the Work of Another Auditor.
6. Companies Act 2013, Section 143 (auditor's report) and Schedule V (KMP remuneration).
7. NFRA Inspection Reports FY 2022-23 and FY 2023-24.