For the sake of simplicity, let me summarize SA320 in simple words

“Information is material if its misstatement could influence the economic decisions of the users taken on the basis of the financial information.”

Factors affecting judgment:

1) Materiality is a relative concept.
2) It may be judged on the basis of the impact of the item on the overall financial statement level.
3) Legal and regulatory requirements for example – disclosure requirements regarding payments to directors.
4) Cumulative effect of small amounts may be considered material.

Audit risk means the risk that the auditor gives an inappropriate audit opinion when financial statements are materially misstated. Materiality is being closely linked to the concept of audit risk in determining the nature, timing and extent of audit procedures.

There is an inverse relationship between materiality and the degree of audit risk which means the higher the materiality level, lower the audit risk and lower the materiality level higher the audit risk. The auditor takes the inverse relationship between materiality and the audit risk into account when determining the nature, timing and extent of audit procedures. For example, if, after planning for specific audit procedures, the auditor determines that the acceptable materiality level is lower, audit risk is increased. In simple words, if the auditor thinks that in this company even Rs.500 is material, it means the auditor is setting the materiality level low.

The auditor would compensate for this either by:
1) Reducing the assessed degree of control risk, where this is possible, and supporting the reduced degree by carrying out extended or additional tests of control, or
2) Reducing detection risk by modifying the nature, timing and extent of planned substantive procedures.

Materiality level may be changed depending upon the experience gained during the audit process. Materiality may be different at the time of initially planning the audit of the engagement from that at the time of evaluating the audit procedure.

Errors detected during the audit may be communicated to the management and the management may be asked to adjust the financial statement. However, if the management does not carry the required adjustment resulting from errors, the auditors after assessing and reviewing may form qualified or adverse opinion.