What is tolerable misstatement?
Most teams just roll it forward. They copy last year's performance materiality into the sampling template and plug it into the sample-size formula without a second thought. That works until a reviewer asks why tolerable misstatement for a high-risk receivables population is identical to the number used for a low-risk prepayments balance. The answer is usually SALY with a methodology shield: the firm's template defaulted to PM and nobody questioned it.
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 performance materiality from the financial statement level down to an individual sampling application.
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." On most engagements, the team sets it equal to PM, though the auditor may set it lower for higher-risk populations.
Key Points
- Tolerable misstatement is PM applied to a specific sampling population. It is always equal to or lower than PM.
- Lower tolerable misstatement requires a larger sample. This is one of the primary drivers of sample size in both statistical and non-statistical sampling.
- After testing, the auditor performs the ISA 530 .A22 dual comparison: projected misstatement vs tolerable misstatement at the population level, and projected misstatement plus other misstatements vs overall materiality at the FS level.
- Even if projected misstatement falls below tolerable misstatement, the auditor must consider whether the sample results suggest a systematic pattern that could signal 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)
- PM: EUR 350,000 (70% of overall materiality)
- Tolerable misstatement for trade receivables: EUR 350,000 (set equal to PM because no additional risk factors were 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.
First, projected misstatement is compared to 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, so the auditor must extend testing or request management to investigate the cutoff error.
Second, projected misstatement plus other misstatements is compared to overall materiality. Even if the first comparison 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
This is the area that generates the most review notes on sampling files.
- Some auditors set tolerable misstatement higher than PM to shrink sample sizes. This defeats the purpose of PM as a buffer and directly contradicts ISA 530 's intent.
- Auditors evaluated sample results against tolerable misstatement but skipped the second leg of the dual comparison. They did not aggregate projected misstatements with other misstatements for the FS-level evaluation.
- The same tolerable misstatement was used for every population. Reviewers expect the auditor to consider whether specific risk factors warrant a lower tolerable misstatement for certain accounts, even when PM is the default starting point.
- We've seen teams document tolerable misstatement in the sampling template but never reference it in the evaluation. The file should tell a story from the threshold set at planning through to the conclusion drawn at evaluation.
Tolerable misstatement vs PM
PM applies to the FS as a whole. Tolerable misstatement applies to a specific sampling population. The team sets PM once during planning (and revises it if needed), while tolerable misstatement is set separately for each sampling application.
Tolerable misstatement is always equal to or less than PM. Where PM provides a buffer against aggregate undetected misstatements across all accounts, tolerable misstatement sets the acceptance threshold for one specific test.
Key standard references
- ISA 530.5 (c) defines tolerable misstatement as the monetary amount set by the auditor for a specific sampling application.
- ISA 530 .A3 confirms that tolerable misstatement is the application of PM to a particular sampling procedure.
- ISA 530 .A11 identifies tolerable misstatement as a factor in determining sample size. A lower tolerable misstatement results in a larger sample.
- ISA 530 .A22 covers the dual comparison of projected misstatement to tolerable misstatement and to overall materiality.
- ISA 320.11 establishes PM, the basis from which tolerable misstatement is derived.
Related terms
Related tools
Related reading
Frequently asked questions
What is the relationship between tolerable misstatement and performance materiality?
Tolerable misstatement is PM applied to a specific account or sampling population. PM 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 PM. On most engagements, tolerable misstatement equals PM 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 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. First, projected misstatement is compared to tolerable misstatement to evaluate the sample result. Second, projected misstatement plus any other known misstatements in the population is compared to overall materiality. Both comparisons must pass. A sample can clear the first test (projected misstatement below tolerable misstatement) but still trigger a concern at the FS level when combined with misstatements from other areas.