DETERMINATION OF PLANNING MATERIALITY, TOLERABLE

MISSTATEMENT, AND THRESHOLDS FOR INDIVIDUALLY

SIGNIFICANT ITEMS AND TRIVIAL AMOUNTS
PURPOSE
This form has been designed to help the auditor determine and document planning materiality and tolerable
misstatement as well as the thresholds for individually significant items and trivial amounts.

INSTRUCTIONS
The auditor should complete the following steps in determining materiality levels for the audit:
1.
2.
3.
4.
5.

Determination of appropriate benchmark(s).

Determination of planning materiality.
Determination of tolerable misstatement.
Determination of the threshold for individually significant items.
Determination of the threshold for trivial amounts.

FASB Statement of Financial Accounting ConceptsNo. 2 (CON-2), Qualitative Characteristics of Accounting

Information, defines materiality as the magnitude of an omission or misstatement of accounting information that, in
the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the
information would have been changed or influenced by the omission or misstatement.This form is designed to help
the auditor apply professional judgment in determining a materiality level that meets this threshold.This form should
be reviewed and approved by the auditor with final responsibility for the audit (e.g., audit partner).

Step 1: Determination of Appropriate Benchmarks

The benchmark should represent the measurement component of the entitys financial statements that is believed to
be the most critical to the users of the financial statements.The benchmark will then be used as the base from which
to determine planning materiality.When identifying an appropriate benchmark, the auditor may consider factors such
as:

The financial statement elements (e.g., assets, liabilities, equity, income, and expenses) and the financial
statement measures defined in generally accepted accounting principles (e.g., financial position, financial
performance, and cash flows), or other specific requirements.
Whether there are financial statement items on which users attention tends to be focused, including
earnings trends, ratios, or financial statement elements used in calculating loan covenants.
The nature of the entity and the industry in which it operates.
The size of the entity, nature of its ownership, and the way it is financed.

The auditor should consider whether the selected benchmark should be normalized in the determination of
materiality.For example, an exceptional increase or decrease in profit may lead to the conclusion that a more
appropriate benchmark is a normalized profit figure based on past results.

Step 2: Determination of Planning Materiality

Determining planning materiality is a matter of professional judgment and the auditor may determine that more than
one benchmark is appropriate for the client.If so, the auditor may choose to determine planning materiality as a
range.This form has been designed to assist the auditor in determining materiality using different benchmarks.

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Professional judgment should be used in selecting a specific dollar amount within this range that represents the
auditors preliminary determination of materiality.
Practice Point:The determination of planning materiality is not a purely mathematical calculation and, therefore, requires judgment in evaluating
the results of applying percentages to a benchmark. In addition to considering the results of the planning materiality mathematical calculation, the
auditor should consider the effect of such items as prior periods financial results and financial positions, the period-to-date financial results and
financial position, budgets or forecasts for the current period, and significant changes in the entitys circumstances (e.g., a significant business
acquisition or changes in the economy or industry).

Consideration of Lesser Materiality Level for Particular Items

The auditor should consider whether circumstances exist that require a lower materiality level for particular items of
lesser amounts than the materiality level determined for the financial statements as a whole.In considering whether a
lesser materiality level is needed for certain items, the auditor should consider:

Whether misstatements of particular financial statement elements could be considered material by users of
the financial statements, even though the misstatement is less than the materiality level established above.
Whether accounting standards, laws, or regulations affect users expectations regarding the measurement
or disclosure of certain items, such as related-partytransactions and management compensation.
The key disclosures in relation to the industry and the environment in which the entity operates.
Whether attention is focused on the financial performance of a particular subsidiary or division that is
separately disclosed in the consolidating financial statements.

Practice Point:Refer to paragraphs 31 to 33 of Statement on Auditing Standards No. 107(SAS-107), Audit Risk and Materiality in Conducting an
Audit, for further guidance on considering lower materiality for particular items of lesser amounts.

Step 3: Determination of Tolerable Misstatement

Tolerable misstatement is the maximum misstatement, whether caused by error or fraud, in a population (i.e., the
class of transaction or account balance) that the auditor is willing to accept.Tolerable misstatement is lower than
planning materiality to account for the possibility that there may be misstatements in a population that will not be
detected.Tolerable misstatement is used in determining sample sizes and in making other decisions regarding the
extent of testing and may be determined as a percentage of planning materiality.
Practice Point:Common practice is to determine tolerable misstatement as a percentage within 50% to 75% of planning materiality, although the
amount can be outside of this range.

Step 4: Determination of the Threshold for Individually Significant Items

In planning the extent of substantive tests of details, such as sampling, the auditor should determine a threshold for
individually significant items (ISIs) that are to be examined 100%. Arriving at such a threshold will help in
determining the sample size for a nonstatistical sample and may be helpful in establishing other scopes for
substantive tests of details.An ISIthreshold is used to determine transactions or accounts that are individually
important because of their size or that the auditor believes have a high risk of material misstatement.Because an
individual item within an account balance, class of transaction, or disclosure that exceeds tolerable misstatement is
likely to be significant, the auditor should consider using tolerable misstatement divided by a factor in defining the
threshold for ISIs.Professional judgment should be applied in determining which additional individual items in an
account balance, class of transaction, or disclosure need to be examined. In determiningthe ISI threshold, the auditor
should consider, in addition to the size of the item, factors such as the following:

Transactions involving estimates and requiring highly subjective judgments (e.g., allowance for doubtful
accounts, inventory valuation adjustments, or percentage-of-completion estimates for a construction
contractor).
Large or unusual transactions recorded as of or near the end of the clients year-end (e.g., large sales just
before or after year-end).
Old items (e.g., past due accounts receivable or slow-moving inventory).

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Transactions having a high degree of management involvement (e.g., related-party transactions).

The factor used to determine the ISI threshold depends on the risk of material misstatement of the relevant assertion
being audited, and the extent to which the auditor is relying on the applicable audit procedure.A smaller factor
would be used when the risk is low or when other procedures provide significant evidence about the relevant
assertion.Because the ISI threshold varies with risk and other factors, the auditor may establish a different ISI
threshold for certain account balances, classes of transaction, or disclosures.
Practice Point:Common practice is to determine the ISI threshold by dividing tolerable misstatement by a factor ranging from three to six,
although smaller factors (i.e., one or two) may be used where the risk of material misstatement is low or where other audit procedures provide
significant evidence about the relevant assertion.

Step 5: Determination of the Threshold for Trivial Amounts

The auditor must accumulate known and likely misstatements identified during the audit, other than those believedto
be trivial.The trivial amount threshold is an amount below which it is determined misstatements need not be
accumulated.This amount is set so that any such misstatements, either individually or when aggregated with other
such misstatements, would not be material to the financial statements, after the possibility of further undetected
misstatements is considered.
Practice Point:Common practice is to set the trivial amount threshold as a percentage within 1% to 5% of tolerable misstatement.

Step 6: Considerations as the Audit Progresses

If the auditor becomes aware of additional significant quantitative or qualitative factors that were not initially
considered but that could be important to users of the financial statements, he or she should reassess the
determination of planning materiality and the results of evidence obtained during the performance of audit
procedures.If the auditor concludes that a lower planning materiality than initially determined is appropriate, the
auditor should reconsider tolerable misstatement and appropriateness of the nature, timing, and extent of further
audit procedures.
Practice Point:Materiality used for planning purposes may not be the same as materiality used for evaluating audit results.For example, when
determining whether uncorrected misstatements are material to the financial statements as a whole, the auditor will consider both quantitative and
qualitative factors (e.g., the effect of uncorrected misstatements on significant trends or ratios).In contrast, materiality for planning purposes
typically considers to a lesser extent these types of qualitative factors.

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