What is performance materiality?
Every busy season, the same question comes up in review: "Why did you pick 75%?" If the only answer in the file is "SALY with a methodology shield" (same as last year, wrapped in boilerplate language), the reviewer sends it back. Performance materiality (PM) is the number that determines how much work you actually do, and regulators have noticed how often firms can't explain it.
PM is the working threshold that auditors use during fieldwork. It sits below overall materiality and acts as a safety margin: by testing at a lower amount, the auditor reduces the probability that the aggregate of uncorrected and undetected misstatements exceeds overall materiality for the financial statements as a whole (the FS as a whole).
ISA 320.11 requires the auditor to determine PM for purposes of assessing the risks of material misstatement and determining the nature, timing, and extent of further audit procedures. The standard does not prescribe a fixed percentage. In practice, most firms apply a range of 50% to 75% of overall materiality, with the exact figure driven by entity-specific judgement.
What drives the choice? Prior-year misstatement history, the quality of the control environment, whether it is a first-year engagement, and the auditor's expectations about misstatements in the current period. A well-controlled entity with minimal audit adjustments in prior years might justify setting PM at 75% of overall materiality, while a higher-risk entity with weak controls and a history of significant adjustments might warrant 50% or lower.
Key Points
- Always lower than overall materiality. PM creates a buffer so that the sum of individually immaterial misstatements does not breach the overall threshold.
- Typical range: 50-75%. The exact percentage is a matter of professional judgement, not a fixed rule. Entity-specific risk factors drive the choice.
- Drives sample sizes and testing thresholds. A lower PM means larger samples and more procedures. A higher one means less testing.
- Must be documented and revisable. The auditor must record the rationale for the chosen percentage and revise it if circumstances change during the audit.
Why it matters in practice
Worked example: Bakker Industrial
Bakker Industrial NV is a mid-market manufacturing company. The audit team sets overall materiality at EUR 400,000 based on 5% of profit before tax (PBT). Stable control environment, no significant misstatements in the prior two years, no unusual transactions in the current period. They set PM at 75% of overall materiality = EUR 300,000.
During interim testing, the team discovers that Bakker changed its revenue recognition policy for long-term contracts without adequate disclosure. The prior-year file also contained two unadjusted misstatements totalling EUR 120,000. Based on these findings, the team reduces PM to 60% = EUR 240,000, increasing sample sizes for substantive testing. You can't just roll it forward when the facts have changed.
What reviewers catch
Regulators consistently identify PM as a weak spot in audit files. This is the area that generates the most review notes at firms we've worked with. Common findings from regulators:
- In the UK, the FRC has flagged insufficient documentation explaining why the chosen percentage was appropriate for the specific engagement. Files simply stated "75% applied" without linking to entity-specific risk factors.
- In the Netherlands, the AFM has noted PM not being revised when auditors identified significantly more misstatements than expected during testing, indicating the original assessment was too high.
- In the US, PCAOB inspection reports have cited tolerable misstatement (the US equivalent of PM) set mechanically at the same percentage across all engagements without considering each audit's circumstances.
- In Australia, ASIC has questioned whether PM was reconsidered when actual misstatements exceeded the auditor's original expectations at interim.
Performance materiality vs. overall materiality
Overall materiality is the headline number. It is the threshold above which misstatements could reasonably influence the economic decisions of financial statement users. The auditor uses it to evaluate the effect of identified misstatements at the conclusion of the audit and to form the audit opinion.
PM is the operational number, the lower threshold used during the audit to design procedures. It exists because the auditor cannot test every transaction. By working at a lower threshold, the auditor builds in a margin for misstatements that remain undetected, making it unlikely their aggregate exceeds overall materiality.
Think of overall materiality as the destination and PM as the route planned with a safety margin built in. You aim to arrive earlier than the deadline to account for delays along the way.
Key standard references
- ISA 320.11 requires determining PM for purposes of assessing the risks of material misstatement and determining the nature, timing, and extent of further audit procedures.
- ISA 320 .A12 lists factors the auditor may consider in determining PM, including the nature and extent of misstatements identified in previous audits.
- ISA 320.12 -13 covers revision of materiality (and consequently PM) as the audit progresses.
- ISA 450 .A2 addresses using PM to assess the significance of accumulated misstatements.
Related terms
Related tools
Related reading
Jurisdiction notes
PM under ISA 320.11 is set at 50-75% of overall materiality across most jurisdictions. In the United Kingdom, the FRC expects auditors to document the specific factors justifying where within the range the percentage is set, including prior-period misstatements and entity-specific risk factors. ISA (UK) 320 is substantively identical to the base ISA. In the Netherlands, NV COS 320.11 applies the same requirement. The AFM has noted that auditors sometimes set PM mechanically without sufficient entity-specific justification. In Australia, ASA 320.11 applies unchanged. ASIC inspections have focused on whether PM is appropriately reconsidered when actual misstatements exceed expectations.
In the United States, AU-C 320.09 defines PM as the amount set below overall materiality to reduce the probability that aggregate uncorrected and undetected misstatements exceed overall materiality. AU-C 320.A3 distinguishes PM from tolerable misstatement, which is its application to a particular sampling procedure (AU-C 530). Under PCAOB AS 2105.08, the equivalent concept is "tolerable misstatement," which must be set below the materiality level for the FS as a whole. AS 2105.09 requires auditors to consider the nature, cause, and amount of prior-period misstatements when determining tolerable misstatement. PCAOB inspection reports have cited mechanical application of tolerable misstatement without adequate consideration of entity-specific factors and prior-period audit results.
Frequently asked questions
What is the difference between performance materiality and overall materiality?
Overall materiality is the threshold for the financial statements as a whole (the amount above which misstatements could influence users' decisions). Performance materiality is set lower (typically 50-75% of overall materiality) to create a buffer. It reduces the risk that the aggregate of individually immaterial, uncorrected and undetected misstatements exceeds overall materiality. The auditor uses performance materiality as the working threshold when designing the nature, timing, and extent of audit procedures.
How do auditors determine the percentage for performance materiality?
ISA 320 does not prescribe a fixed percentage. The auditor exercises professional judgement based on entity-specific factors: prior-year misstatement history, the quality of the control environment, whether the entity is a first-year audit, and the auditor's expectations about misstatements in the current period. A well-controlled entity with few prior-year misstatements might justify a higher percentage (e.g., 75%), while a higher-risk entity with weak controls and a history of adjustments might warrant 50% or lower.
Can performance materiality be different for different account balances?
Yes. Although performance materiality is typically set as a single amount for the financial statements as a whole, the auditor may set different amounts for particular classes of transactions, account balances, or disclosures if specific materiality applies under ISA 320.10. For example, if related party transactions have a lower specific materiality, the corresponding performance materiality for that area would also be lower.