Materiality in Audit: Overall, Performance and Trivial

A misstatement is material if it could change the decisions of someone reading the financial statements. Auditors turn that idea into numbers at planning, use the numbers to size their testing, and use them again at the end to judge what they found.

The standards are AU-C 320 (private companies), ISA 320 and CAS 320, and AS 2105 for public companies. Evaluating misstatements at the end falls under AU-C 450 and ISA 450.

The three numbers

Amount	What it is for	Typical size
Overall materiality	The level above which misstatements, alone or together, would change the opinion	A percentage of a benchmark
Performance materiality	A lower amount used to plan and run testing, so that undetected and uncorrected misstatements together stay below overall materiality	Often 50% to 75% of overall
Clearly trivial threshold	Misstatements below it don't need to be accumulated	Often 3% to 5% of overall

Firms usually set their own ranges in their methodology. The figures above are common starting points.

Picking a benchmark

Benchmark	Common range	When it fits
Profit before tax	5%	Profit-oriented entities with stable earnings
Revenue	0.5% to 1%	Entities near break-even, or where revenue is the focus
Total assets	1% to 2%	Asset-heavy entities, investment entities
Equity	1% to 5%	Entities where net assets matter most to users
Total expenses	0.5% to 2%	Not-for-profits and public sector

Use the benchmark the readers of the statements care about. If profit swings from year to year, a normalized or average profit, or a different benchmark, gives a steadier number.

Worked example

A manufacturing client has revenue of $40 million and profit before tax of $2.4 million that has been steady for three years.

• Overall materiality: 5% × $2,400,000 = $120,000
• Performance materiality, at 75% because the client has few past misstatements: $90,000
• Clearly trivial threshold, at 5% of overall: $6,000

The auditor would use $90,000 when setting sample sizes and choosing which items to test individually, and would record every misstatement found above $6,000.

Specific materiality

Some balances or disclosures matter to readers at much smaller amounts, such as related party transactions or management pay. The auditor can set a lower materiality for those items.

Revising it during the audit

Materiality is set on draft or prior numbers. If the final numbers differ a lot, or something new comes up, revise it. If the new amount is lower, check that the testing already done is still enough.

At the end of the audit

Add up the uncorrected misstatements, including projected misstatements from samples, and compare the total with materiality. Look at the nature of each one as well as its size. A small misstatement can still be material if it turns a profit into a loss, breaks a loan covenant or involves fraud.

Where Warp Accounting fits

Warp Accounting runs the test of details once the firm has set materiality. The firm sets the sample size or sampling interval from its own performance materiality, Warp draws the sample and vouches it, and each exception in the working paper shows its amount for the firm to evaluate. In journal entry testing, entries above performance materiality are one of the criteria. See test of details, and our guides to audit sampling and audit risk.