What is performance materiality?
Performance materiality 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.
ISA 320.11 requires the auditor to determine performance materiality 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.
The percentage chosen depends on factors such as the entity's 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 performance materiality 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. Performance materiality 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.
- It determines sample sizes and testing thresholds. A lower performance materiality 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. The team considers that the entity has a stable control environment, no significant misstatements in the prior two years, and no unusual transactions in the current period. They set performance materiality at 75% of overall materiality = EUR 300,000.
During interim testing, the team discovers that the entity changed its revenue recognition policy for long-term contracts without adequate disclosure, and the prior-year file contained two unadjusted misstatements totalling EUR 120,000. The team reassesses and reduces performance materiality to 60% = EUR 240,000, increasing sample sizes for substantive testing.
What reviewers catch
Regulators consistently identify performance materiality as a weak spot in audit files. Common findings include:
- FRC (UK): Insufficient documentation explaining why the chosen percentage was appropriate for the specific engagement. The file simply stated "75% applied" without linking to entity-specific risk factors.
- AFM (Netherlands): Performance materiality not revised when the auditor identified significantly more misstatements than expected during testing, indicating the original assessment was too high.
- PCAOB (US): Tolerable misstatement (the US equivalent) set mechanically at the same percentage across all engagements without considering the unique circumstances of each audit.
Performance materiality vs overall materiality
Overall materiality is the headline number — 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.
Performance materiality 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, ensuring their aggregate is unlikely to exceed overall materiality.
Think of overall materiality as the destination and performance materiality 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: Determining performance materiality for purposes of assessing the risks of material misstatement and determining the nature, timing, and extent of further audit procedures.
- ISA 320.A12: Factors the auditor may consider in determining performance materiality, including the nature and extent of misstatements identified in previous audits.
- ISA 320.12–13: Revision of materiality (and consequently performance materiality) as the audit progresses.
- ISA 450.A2: Using performance materiality to assess the significance of accumulated misstatements.
Related terms
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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.