Materiality in an audit is the size of error that would change the decisions of someone relying on your financial statements. Under ISA 320, the auditor sets it as a percentage of a benchmark, such as 5% of profit before tax for a manufacturer. Errors below it can pass. Errors above it, alone or added together, must be corrected or the audit opinion is modified.
With most Nigerian companies closing their books on 31 December, now is the time to understand the number your auditor is about to set.
What is materiality in an audit?
Your auditor does not check every transaction. An audit gives reasonable assurance, not absolute assurance, that the accounts are free from material misstatement. Materiality is the line that separates the errors that matter from those that do not.
ISA 320, the International Standard on Auditing on materiality, says misstatements are material if they could reasonably be expected to influence the economic decisions of users. In Nigeria those users are usually your bank, your investors, the Nigeria Revenue Service (NRS) and regulators such as the Financial Reporting Council of Nigeria (FRC).
Materiality is a matter of professional judgement. The standard gives a starting point, not a formula.
How do auditors calculate materiality?
The auditor picks a benchmark that reflects what users of your accounts care about, then applies a percentage to it. ISA 320 lists common benchmarks:
- Profit before tax. Often used for profit-making companies.
- Total revenue or gross profit. Used when profit is volatile or close to zero.
- Total expenses. Common for NGOs and not-for-profits.
- Total equity or net assets. Used for some asset-holding entities.
The standard's own examples are 5% of profit before tax for a manufacturing company and 1% of total revenue or total expenses for a not-for-profit. It also says higher or lower percentages may be appropriate. Here is how that looks in naira:
- Manufacturer with ₦400 million profit before tax: materiality of about ₦20 million at 5%.
- NGO with ₦900 million of annual expenses: materiality of about ₦9 million at 1%.
- Trading company with ₦2 billion revenue and thin, volatile profit: the auditor may switch to a revenue benchmark instead.
What is performance materiality?
Overall materiality is not the threshold your auditor actually works to. ISA 320 warns that planning only for individually material errors overlooks the risk that many small errors add up to a material one.
So the auditor also sets a lower figure, called performance materiality, for testing individual balances. If overall materiality is ₦20 million, performance materiality might be set well below that. The standard says this is a judgement, not a mechanical calculation.
Under ISA 450, the auditor records every misstatement found, other than those that are clearly trivial, and then decides whether the uncorrected ones are material individually or in aggregate. Ten ₦3 million errors are a ₦30 million problem.
Can a small error still be material?
Yes. Materiality is not only about size. ISA 320 notes that smaller amounts can still influence users for particular items, including:
- Related party transactions. Dealings with directors, shareholders or group companies.
- Remuneration of management and directors. Users and regulators pay close attention to these figures.
- Key industry disclosures. For example, reserves information in oil and gas, or loan loss disclosures in banking.
ISA 450 adds that a misstatement that increases management compensation, or that relates to particular parties, can be material even below the threshold. Errors from prior years can also build up until they become material in the current year.
What this means for your business
Materiality shapes how much work your auditor does, what they ask for, and which adjustments they push back on. Finance teams that understand it get a smoother year-end.
- Ask your auditor for the figure early. Overall and performance materiality are set at planning. Knowing them helps you focus your clean-up on the balances that matter most.
- Fix small errors anyway. Uncorrected differences are added together. A schedule of "immaterial" items left over from last year can tip this year over the line.
- Treat sensitive items carefully. Related party balances, directors' pay and loan covenant figures get extra scrutiny even when the amounts are small. Document them fully.
- Watch your benchmark. If profit has dropped sharply, your auditor may change benchmark, and the threshold can move a long way.
- Remember the tax link. An adjustment that is material for the audit can also change your taxable profit and your NRS return.
For a full year-end plan, see our 11-week year-end audit checklist. For why a clean opinion has limits, read Does a clean audit report mean your company is fraud-free?
FAQ
Who sets materiality, the company or the auditor? The auditor sets it, using professional judgement under ISA 320. Management cannot set it, but you can discuss the benchmark and ask how it was chosen. Those charged with governance often do.
Is materiality the same as the tax authority's threshold? No. Audit materiality is a reporting concept. The NRS can assess tax on any underpayment, whatever its size, so an error your auditor accepts as immaterial can still lead to tax, interest and penalties.
Can materiality change during the audit? Yes. ISA 320 requires the auditor to revise it if new information shows the original figure was wrong, for example where actual results turn out very different from the forecast used at planning.
Getting ready for your 31 December audit? VOG Global's audit and assurance team helps Nigerian businesses close their books cleanly, resolve misstatements before the auditor arrives, and line up the audit with their tax position. Contact us at vog.global to book a year-end readiness review.