Page 93 - Internal Auditing Standards

Guide to Using International Standards on Auditing in the Audits of Small- and Medium-Sized Entities Volume 1—Core Concepts

Auditors are sometimes tempted to lower the overall materiality amount when the risk of material
misstatement is assessed as high. This would not be appropriate, however, as overall materiality addresses the

needs of financial statements users, not the level of audit risk involved.
If audit risk was a factor in setting overall materiality, a high-risk audit would end up with a lower overall
materiality amount than that set for a similar-sized entity where audit risk was low. Assuming that the

information needs of financial statement users are the same, regardless of audit risk, setting the overall
materiality amount at a lower level would result in:

• Providing financial statement users with an expectation that smaller misstatements in the fi nancial

statements (than is actually necessary) will be identified by the auditor; and
• Additional audit work to ensure that audit risk has been reduced to an appropriately low level.

Because overall materiality is set in relation to the needs of financial statement users, it would not be changed

as a result of audit findings and changes in assessed risks. Overall materiality is required to be updated when

the auditor becomes aware of information that would have caused the initial determination of materiality to
be a different amount (or amounts).

At the conclusion of the audit, overall materiality will be used for evaluating the effect of identifi ed
misstatements on the financial statements and the appropriateness of the opinion in the auditor’s report.

Performance Materiality
Performance materiality allows the auditor to address the risks of misstatement in account balances, classes
of transactions, and disclosures without having to change overall materiality. Performance materiality
enables the auditor to establish materiality amounts that are based on the overall materiality, but are set at
lower amounts to reflect the risk of not detecting misstatements and to reflect risk assessments. This lower

amount(s) establishes a safety buffer between the materiality used for determining the nature and extent of

testing (performance materiality) and the materiality amount for the financial statements as a whole (overall
materiality).
Setting an appropriate amount for performance materiality will ensure that more work is performed, which
increases the likelihood that misstatements (if they exist) will be identified. For example, if overall materiality

was 20,000Є and audit procedures were planned to detect all errors in excess of 20,000Є, it is quite possible
that an error of, say, 8,000Є would go undetected. If three such errors existed, amounting to 24,000Є, the

financial statements would be materially misstated. However, if performance materiality was set at 12,000Є, it
would be much more likely that at least one or all of the 8,000Є errors would be detected. Even if only one of

the three errors was identified and corrected, the remaining misstatement of 16,000Є would be less than the
overall materiality, and the financial statements as a whole would not be materially misstated.

Setting an appropriate amount for performance materiality involves the exercise of professional judgment,
and is not a simple mechanical calculation such as a percentage (e.g., 75%) of the overall materiality level.
However, based on the particular circumstances of the entity being audited, it could be set as a single amount

for the financial statements as a whole, or at individual amounts for particular balances, transactions, and
disclosures.

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