Auditing and Assurance Principles

Materiality
Audit Planning Activities: Define Materiality

Perceived need of users

Benchmark (for example, Income before Tax)

Overall materiality (smallest aggregate amount of misstatement

applicable to all financial statements)

Performance materiality (amounts set by the auditor at less than

overall materiality) and Specific materiality (amounts set by
auditor at less than overall materiality for specific accounts)

Clearly trivial threshold (amount below which misstatements

would be clearly trivial and would not need to be accumulated)
 Appropriate benchmarks
• Profit before tax
Overall Materiality • Total income
(materiality for the financial • Gross profit
statements as a whole) • Total equity
• Total assets

Example: Overall Materiality 2023 2022

Using Total Revenue
Revenues P 120,000,000 P 80,000,000

Percentage of Revenues 1% 1.5%

Overall Materiality P 1,200,000 P 1,200,000

Note: In 2022, 1.5% of Revenues was used to determine the overall materiality. However, in 2023, the
current year’s rise in revenue is not expected to be repeated in future years due to exceptional orders
during the year. Also, auditors assessed higher risks in 2022 thereby assigning a lower materiality
percentage.

Performance
Materiality
(working materiality, helps
guide auditors to do enough
work to support their audit)
Note: Usually audit methodologies require performance materiality to be a % of overall materiality. The
higher the assessed risk, the lower the percentage. Typically, the percentage range from 75% (low
risk) to 50% (high risk).
Example:
Amount of Prepayments
Scenario 1: P100,000
Scenario 2: P700,000
Scenario 3: P1,500,000
Two functions:
• Reduce the aggregation risk (the aggregate of
uncorrected and undetected misstatements
individually below materiality will exceed overall
materiality)
• Provide a safety net against risk of undetected
misstatements.
2023 Planned Approach
Assuming Performance Materiality is 50% of Overall Materiality
Do nothing as there is no risk of material misstatement.
More than performance materiality, but not significant. Auditors may
carry out analytical procedures based on expected prepayments.
As this is considerably more than performance materiality,
more evidence is needed to be deemed sufficient. For
example, auditors may decide to test a sample of individual
transactions.
 If lower materiality has been set for specific
balances, classes of transactions or disclosures
Specific Materiality auditors will need to apply a lower performance
materiality here as well.

Example Overall Materiality Planning Materiality

Related party transactions P 100,000 P 75,000

The auditor should set a monetary benchmark below

which misstatements are considered to be clearly
Clearly Trivial trivial and would not need to be accumulated. For
instance, the level below which misstatements are
Threshold deemed to be trivial has been set at 5% of overall
materiality or P60,000.