Materiality – The Auditor's Report

Don’t think of materiality like this – start with the over/under/misstatement:

Inventory is overstated by $0.75 ($0.85-$0.1) i.e. current assets in the SoFP are overstated by $0.75 and profit is overstated by $0.75

Now ask “is this material?”. Well, the effect on PBT is $0.75/ $5.6 is 13.4%, which is clearly material as it well exceeds 5% (and even 10%) – our “benchmark” for profit.
Having established that it’s material there is no need to do any further calculations. If however, the answer had been “bordeline” material we would most likely also calculate $0.75 as a % of total assets (if given) and compare it with the 1-2% total asset’s guideline.

What we would NOT do is calculate a % on revenue because the misstatement has NO effect whatsoever on revenue and is therefore irrelevant.

Here’s another example to illustrate the point of relevancy (same PBT and revenue as in your example, and suppose total assets are $700m):

A bank overdraft balance of $12m has been offset against cash at bank and shown as a current liability of $3.5m – here you have to start by being careful with the amount of the error – it is $8.5m. (If the result of offsetting was a current asset, the error would be $12m.) The error is in presentation – it has NO effect on revenue and NO effect on profit.
It does, however, affect total assets – $8.5/$700 = 1.2% and is therefore material (as it exceeds 1%)

You are very welcome!