Side-by-side comparison
| Dimension | Materiality | PM |
|---|---|---|
| What it controls | The threshold for the audit opinion | The threshold for designing and performing audit procedures |
| Who it serves | Financial statement users (through the auditor’s opinion) | The engagement team (determines scope and sample sizes) |
| When you set it | Planning stage, reassessed at completion | Planning stage, reassessed at completion |
| How it’s expressed | A single amount for the financial statements as a whole | A percentage or fixed reduction of materiality |
| Common range | 1–2% of revenue, 5–10% of PBT, 1% of total assets | 50–75% of materiality (engagement-specific) |
| What drives the level | Benchmark selection, engagement-specific factors | Expected and prior-year misstatements, risk profile |
Key points
- Materiality sets the bar for the opinion. Performance materiality (PM) sets the bar for your testing.
- PM is always lower than materiality because it builds in a buffer for undetected misstatements.
- Most inspection findings relate to PM being set without documented rationale, not to the materiality figure itself.
- Changing one without reconsidering the other is a common file deficiency.
When the distinction matters on an engagement
We’ve seen teams clear review with a misstatement schedule that compares every item to PM, then treat anything below PM as resolved. That’s wrong. ISA 450.11 requires the auditor to determine whether uncorrected misstatements are material, individually or in aggregate, and the comparison is to materiality (not PM). A €90K misstatement that sits comfortably below PM still counts toward the aggregate that gets measured against the opinion threshold. Teams that confuse the two sometimes conclude that misstatements below PM don’t require evaluation. They do.
PM is a planning tool. It drives sample sizes and tolerable misstatement thresholds in sampling applications. But the final opinion question is always: does the aggregate of uncorrected misstatements exceed materiality? The gap between the two figures is the auditor’s buffer against undetected misstatements. ISA 320 .A13 acknowledges that determining PM involves judgment. A first-year engagement with no history of misstatements might justify PM at 75% of materiality. An engagement with a pattern of prior-year adjustments might need 50% or lower. At firms like ours, we’ve found that anything below 60% on a recurring engagement usually means the team has identified specific estimation risk. The file must document why.
Worked example: Koenders Precisie B.V.
Client: Dutch precision engineering company, FY2024, revenue €28M, Dutch GAAP (RJ) reporter. Third-year engagement.
Setting materiality
The engagement team selects revenue as the benchmark. Materiality is set at 1% of revenue: €280K. Revenue was chosen over profit before tax (PBT) because PBT swung from a €400K loss in FY2023 to an expected €600K profit in FY2024, making it too volatile.
Documentation note: Record the benchmark (revenue), the percentage applied (1%), the resulting materiality (€280K), and the rationale for selecting revenue over PBT. ISA 320 .A3 provides guidance on benchmark selection.
Setting PM
Prior-year uncorrected misstatements totalled €95K across two items. The engagement has no history of material adjustments, but inventory valuation involves estimation uncertainty (slow-moving stock provisions). The team sets PM at 55% of materiality: €154K.
Documentation note: Record PM (€154K) and the percentage of materiality (55%). Document the factors that drove the reduction below the typical 60%–75% range. ISA 320 .A12 identifies relevant factors: the nature and extent of misstatements identified in previous audits, and the auditor’s expectations about misstatements in the current period.
Using both during testing
Sample sizes for revenue testing and inventory valuation are calculated using PM of €154K, not materiality of €280K. Tolerable misstatement in sampling applications is set at €154K. During testing, the team identifies an uncorrected inventory provision understatement of €110K.
Documentation note: Record how PM drove sample sizes (include the calculation). List all identified misstatements above the clearly trivial threshold (€14K, 5% of materiality) and the nature of each.
Evaluating at completion
The €110K uncorrected misstatement is below PM (€154K) and well below materiality (€280K). The team considers whether additional undetected misstatements might exist and concludes that the buffer between €110K and €280K is sufficient given the low prior-year misstatement history. No modification to the opinion is needed.
Documentation note: Present the misstatement summary, the comparison to both thresholds, the auditor’s conclusion on whether the aggregate could exceed materiality, and the basis for that conclusion.
Materiality (€280K) determined the opinion. PM (€154K) determined the sample sizes. If the team had confused the two and used €280K as the tolerable misstatement for sampling, the sample would have been smaller. The €110K misstatement might not have been detected at all.
What reviewers get wrong
The AFM’s thematic review of materiality found that firms frequently set PM as a fixed percentage of materiality (typically 75%) without documenting why that percentage was appropriate for the specific engagement. That’s just rolling it forward. ISA 320 .A13 requires the auditor to consider factors including the nature and extent of misstatements identified in previous audits. A percentage applied without reference to engagement-specific factors doesn’t satisfy the standard. It is one of the most common inspection findings we see, and it’s entirely avoidable with two paragraphs of documentation.
Teams sometimes revise materiality at completion (because final financial results differ from planning estimates) without reconsidering PM. ISA 320.12 requires reassessment of both. If materiality increases at completion, PM may also change, but the audit procedures were already performed at the planning-stage threshold. The file must address this gap explicitly.
Key standard references
- ISA 320.9 defines materiality for the financial statements as a whole.
- ISA 320.11 requires the auditor to determine PM for purposes of assessing risks and designing further audit procedures.
- ISA 320.12 requires revision of materiality and PM if information becomes available that would have caused a different amount.
- ISA 320 .A13 provides guidance on factors to consider when determining PM.
- ISA 450.11 requires the auditor to determine whether uncorrected misstatements are material, individually or in aggregate.
Related terms
Related tools
Related reading
Frequently asked questions
Why is performance materiality always lower than materiality?
Performance materiality builds in a buffer for undetected misstatements. If the auditor tested at the full materiality level, any combination of undetected misstatements could push the aggregate above the opinion threshold. ISA 320.11 requires the auditor to set performance materiality below materiality to reduce this probability to an appropriately low level.
Can you change materiality at completion without changing performance materiality?
ISA 320.12 requires the auditor to revise materiality if information becomes available that would have caused a different amount to be set initially. When materiality changes, performance materiality must be reconsidered as well. Revising one without documenting the impact on the other is a common inspection finding.