(a) Materiality and performance materiality
Materiality and performance materiality are dealt with under ISA 320 Materiality in Planning and Performing an Audit. Auditors need to establish the materiality level for the financial statements as a whole, as well as assess performance materiality levels,which are lower than the overall materiality for the financial statements as a whole.
Materiality
Materiality is defined in ISA 320 as follows: ‘Misstatements, including omissions, are considered to be material if they,individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements.’
If the financial statements include a material misstatement, then they will not present fairly (give a true and fair view) the position, performance and cash flows of the entity.
A misstatement may be considered material due to its size (quantitative) and/or due to its nature (qualitative) or a combination of both. The quantitative nature of a misstatement refers to its relative size.
A misstatement which is material due to its nature refers to an amount which might be low in value but due to its prominence and relevance could influence the user’s decision, for example, directors’ transactions.
As per ISA 320, materiality is often calculated using benchmarks such as 5% of profit before tax or 1% of total revenue or total assets. These values are useful as a starting point for assessing materiality, however, the assessment of what is material is ultimately a matter of the auditor’s professional judgement.
It is affected by the auditor’s perception of the financial information, the needs of the users of the financial statements and the perceived level of risk; the higher the risk, the lower the level of overall materiality.
In assessing materiality, the auditor must consider that a number of errors each with a low value may, when aggregated, amount to a material misstatement.
Performance materiality
Performance materiality is defined in ISA 320 as follows: ‘The amount set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.’
Hence performance materiality is set at a level lower than overall materiality for the financial statements as a whole. It is used for testing individual transactions, account balances and disclosures. The aim of performance materiality is to reduce the risk that the total of all of the errors in balances, transactions and disclosures exceeds overall materiality.
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