Materiality in Auditing: Overall Materiality vs Performance Materiality
By SimplyCPA · 11 October 2026
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- Meaning: Misstatements, including omissions, are material if there is a substantial likelihood that, individually or together with other misstatements, they would influence the judgement of a reasonable user of the financial statements.
- Determination: Before detailed testing, the auditor sets materiality using an appropriate benchmark (such as profit, revenue or total assets), a suitable percentage and professional judgement, considering both the size and the nature of potential misstatements.
- Overall and performance materiality: Overall materiality applies to the financial statements as a whole. Performance materiality is set lower, to reduce the risk that undetected and uncorrected misstatements together exceed overall materiality. A lower level may also be set for specific balances, transaction classes or disclosures.
- Qualitative materiality: Even a small misstatement can be material if it involves fraud, hides a regulatory violation or turns a loss into a profit.
- Audit impact: Materiality drives the nature, timing and extent of audit procedures, and how the auditor evaluates misstatements found and their effect on the audit opinion.
The definition
Under US auditing standards (AU-C 320), misstatements — including omissions — are material if there is a substantial likelihood that, individually or in total, they would influence the judgement made by a reasonable user based on the financial statements.
This wording came from Statement on Auditing Standards (SAS) No. 138, effective for audits of periods ending on or after December 15, 2020. It replaced the older "could reasonably be expected to influence" language and brought the AICPA's definition into line with the Financial Accounting Standards Board (FASB), the Public Company Accounting Oversight Board (PCAOB), the Securities and Exchange Commission (SEC) and US courts.
Materiality is a judgement, not a formula
Auditors commonly start from a benchmark and apply a percentage. Typical starting points are:
| Benchmark | Typical range | Used when |
|---|---|---|
| Pre-tax income | about 5% | Stable, profit-making entities |
| Total revenue | about 0.5%–1% | Volatile or loss-making entities |
| Total assets | about 0.5%–1% | Asset-heavy entities, investment funds |
| Total expenses | about 0.5%–2% | Not-for-profits |
These are conventions used in practice, not rules from the standards. The auditor then adjusts for qualitative factors.
The levels of materiality
- Materiality for the financial statements as a whole — the overall threshold.
- Performance materiality — set lower (often 50%–75% of overall materiality) to reduce the risk that uncorrected and undetected misstatements together exceed overall materiality.
- Specific materiality — a lower threshold for particular accounts or disclosures users care about more, such as executive compensation or related-party transactions.
- Clearly trivial threshold — below this, misstatements needn't even be accumulated.
Worked example: setting and using materiality
A stable, profitable manufacturer reports pre-tax income of $4,000,000.
- Overall materiality = 5% × $4,000,000 = $200,000.
- Performance materiality — the auditor expects a few misstatements based on prior years and sets it at 70%: $140,000. Sample sizes and scoping for each account are driven by this lower figure.
- Specific materiality for related-party disclosures, which the lender scrutinises: $50,000.
- Clearly trivial threshold — 5% of overall: $10,000. Misstatements below this aren't accumulated.
At the end of the audit, the auditor has accumulated uncorrected misstatements of $120,000 (an inventory overstatement of $90,000 and an unrecorded accrual of $30,000). That's below $200,000, so the statements aren't materially misstated quantitatively — but the auditor still asks management to correct them, considers qualitative factors, and reassesses whether the remaining undetected misstatement could push the total over materiality.
Revising materiality during the audit
Materiality is set at planning using estimates, often before year-end figures are final. If the actual results turn out materially different (for example, profit falls sharply) or new information emerges, the auditor revises overall and performance materiality and considers whether the planned procedures are still sufficient.
Communicating misstatements
All accumulated misstatements (other than clearly trivial ones) must be communicated to management on a timely basis, with a request to correct them. Uncorrected misstatements are communicated to those charged with governance, and management's written representations include a statement that it believes their effects are immaterial.
Qualitative materiality
A small misstatement can still be material if it turns a loss into a profit, hides a covenant breach, affects a trend, involves fraud or illegal acts, or relates to management compensation. Expect at least one AUD question built around this idea.
How AUD tests it
- Choosing an appropriate benchmark for a described entity.
- Calculating and comparing overall and performance materiality.
- Evaluating whether accumulated misstatements require a modified opinion.
For a full walkthrough, see audit planning and materiality and assessing the risk of material misstatement.