An auditor has determined preliminary materiality for the financial statements as a whole to be $100,000. During the audit planning phase, the auditor identifies a high risk of fraud related to revenue recognition and numerous complex, non-routine transactions. How should the auditor adjust the performance materiality for specific account balances or classes of transactions?
- AEliminate the concept of performance materiality for high-risk accounts.
- BMaintain performance materiality at a fixed percentage, such as 75% of overall materiality, regardless of risk.
- CSet performance materiality at a higher amount, such as $75,000.
- DSet performance materiality at a lower amount, such as $40,000.
Show answer & explanationAnswer & explanation
Correct answer: D. Set performance materiality at a lower amount, such as $40,000.
Performance materiality is set at an amount less than overall materiality to reduce the probability that the aggregate of uncorrected and undetected misstatements exceeds overall materiality. When the risk of material misstatement (including fraud risk) is high, the auditor should set performance materiality at a lower amount to increase the precision of audit procedures and reduce the risk of undetected misstatements.
Why the other options are wrong
- A. Performance materiality is a critical concept for all accounts, especially high-risk ones, to guide the scope of testing.
- B. While a fixed percentage is a common starting point, performance materiality must be adjusted based on the assessed risk of material misstatement.
- C. Setting performance materiality higher would increase the risk of undetected misstatements, which is inappropriate when fraud risk is high.
Performance Materiality
The amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.
- Used for planning and performing audit procedures.
- Typically 50-75% of overall materiality.
- Lower when risk of material misstatement is higher.
Memory trick: High risk? Lower the bar for what's material to catch more!