F8 Performance materiality

ISA 320 gives this definition:

Performance materiality means 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.

By interpreting this definition, it shows that performance materiality/planning materiality (PM) is set to reduce the risk that misstatements are too large.

Auditor will first determine the PM based on eg. 5% of profit before tax or larger amount if the company is very large, then any item that is more than this materiality level will be tested, ie. considered to be material. For those items less than this materiality level, ie. considered immaterial, sample will be taken for testing.

Later, errors will be projected to be compared to the materiality set for the financial statements as a whole (let's call it final materiality here). When the projected errors are still larger than final materiality, then auditor will consider whether to revise the PM.

Note that the setting of PM requires the exercise of professional judgement.

In conclusion, ISA 320 also states that the purpose of determining performance materiality is to assess the risks of material misstatement and determining the nature, timing and extent of further audit procedures. :)