What is tolerable misstatement?
Tolerable misstatement is the maximum monetary error in a specific population that the auditor is willing to accept and still conclude that the audit objective for that population has been achieved. It translates the concept of performance materiality from the financial statement level down to an individual sampling application.
When an auditor designs a test of details for trade receivables, they need a threshold against which to evaluate the sample results. That threshold is tolerable misstatement. It answers the question: "How much total error in this account am I willing to accept before concluding there may be a material misstatement?"
ISA 530 defines tolerable misstatement as "a monetary amount set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is not exceeded by the actual misstatement in the population." In practice, it is typically set equal to performance materiality, though the auditor may set it lower for higher-risk populations.
Key Points
- Performance materiality at the account level. Tolerable misstatement is the application of performance materiality to a specific sampling population. It is always equal to or lower than performance materiality.
- Inverse relationship with sample size. Lower tolerable misstatement requires a larger sample. This is one of the primary drivers of sample size in both statistical and non-statistical sampling approaches.
- The dual comparison (ISA 530.A22). After testing, the auditor performs two evaluations: projected misstatement vs tolerable misstatement (population-level), and projected misstatement plus other misstatements vs overall materiality (financial statement-level).
- Not a safe harbour. Even if projected misstatement is below tolerable misstatement, the auditor must consider whether the sample results suggest a systematic pattern of misstatement that could indicate a larger problem.
Why it matters in practice
Worked example: Bakker Industrial — MUS on trade receivables
Dekker Accountancy audits Bakker Industrial BV, a mid-market manufacturing company. The audit team sets the following materiality levels:
- Overall materiality: EUR 500,000 (based on 5% of profit before tax)
- Performance materiality: EUR 350,000 (70% of overall materiality)
- Tolerable misstatement for trade receivables: EUR 350,000 (set equal to performance materiality — no additional risk factors identified for this population)
The trade receivables population totals EUR 12,400,000 across 840 invoices. The auditor uses monetary unit sampling (MUS) with a confidence factor of 3.0 (95% confidence, zero expected errors), calculating a sample size of 36 items (EUR 12,400,000 / EUR 350,000 * 3.0 / 3.0 = 36, rounded).
Testing identifies two misstatements:
- Invoice #4,271: recorded at EUR 18,500, confirmed at EUR 17,200. Misstatement: EUR 1,300 (tainting factor: 7.0%).
- Invoice #6,089: recorded at EUR 42,000, confirmed at EUR 42,000 but relates to a January 2026 delivery. Cutoff misstatement: EUR 42,000 (tainting factor: 100%).
The auditor projects the misstatements across the population using MUS projection and then performs the ISA 530.A22 dual comparison:
- Comparison 1 — projected misstatement vs tolerable misstatement. The projected misstatement (EUR 368,667) exceeds tolerable misstatement (EUR 350,000). The sample result does not support the conclusion that the population is free of material misstatement. The auditor must extend testing or request management to investigate the cutoff error.
- Comparison 2 — projected misstatement plus other misstatements vs overall materiality. Even if Comparison 1 had passed, the auditor adds any other known misstatements from other audit areas. If the aggregate approaches or exceeds EUR 500,000, a modified opinion or adjustment is required.
What reviewers catch
- Tolerable misstatement set above performance materiality. Some auditors set tolerable misstatement higher than performance materiality to reduce sample sizes. This defeats the purpose of performance materiality as a buffer and is a direct violation of ISA 530's intent.
- No dual comparison performed. Auditors evaluated sample results against tolerable misstatement but did not aggregate projected misstatements with other misstatements for the financial statement-level evaluation.
- Same tolerable misstatement for all populations. Reviewers expect the auditor to consider whether specific risk factors warrant a lower tolerable misstatement for certain accounts, even if performance materiality is used as the default.
Tolerable misstatement vs performance materiality
- Scope. Performance materiality applies to the financial statements as a whole; tolerable misstatement applies to a specific sampling population.
- Setting. Performance materiality is set once during planning (and revised if needed); tolerable misstatement is set for each sampling application.
- Relationship. Tolerable misstatement is always equal to or less than performance materiality.
- Purpose. Performance materiality provides a buffer against aggregate undetected misstatements; tolerable misstatement sets the acceptance threshold for a specific test.
Key standard references
- ISA 530.5(c): Definition of tolerable misstatement — the monetary amount set by the auditor for a specific sampling application.
- ISA 530.A3: Tolerable misstatement is the application of performance materiality to a particular sampling procedure.
- ISA 530.A11: Tolerable misstatement as a factor in determining sample size — lower tolerable misstatement results in a larger sample.
- ISA 530.A22: Evaluating results — the dual comparison of projected misstatement to tolerable misstatement and to overall materiality.
- ISA 320.11: Performance materiality — the basis from which tolerable misstatement is derived.
Related terms
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Frequently asked questions
What is the relationship between tolerable misstatement and performance materiality?
Tolerable misstatement is performance materiality applied to a specific account or sampling population. Performance materiality is set at the financial statement level (typically 50-75% of overall materiality). When the auditor designs a sampling application for a specific account — such as trade receivables — they set tolerable misstatement at or below performance materiality. In practice, tolerable misstatement often equals performance materiality unless the auditor has reason to set it lower for a particular population.
How does tolerable misstatement affect sample size?
Tolerable misstatement and sample size have an inverse relationship. A lower tolerable misstatement requires a larger sample to achieve the same confidence level. This is because the auditor needs more evidence to conclude that misstatements in the population do not exceed a tighter threshold. Conversely, a higher tolerable misstatement allows a smaller sample. ISA 530.A11 confirms that tolerable misstatement is one of the primary factors determining sample size.
What is the ISA 530.A22 dual comparison?
After completing a sampling application, the auditor performs two comparisons: (1) the projected misstatement is compared to tolerable misstatement to evaluate the sample result, and (2) the projected misstatement plus any other known misstatements in the population are compared to overall materiality. Both comparisons must be satisfied. A sample can pass the first test (projected misstatement below tolerable misstatement) but still trigger a concern at the financial statement level when combined with misstatements from other areas.