Performance Materiality and Its Importance In Auditing
Laypeople may not understand terms such as rebalancing, compound interest, capital gains, or equity. But they hold incredible importance in the world of finance. Each word means something different and significant, helping auditors, chartered accountants, and other finance employees to go about their daily work.
Subsequently, auditors are well aware of performance materiality definition and meaning. However, ordinary people will have to look closely at it in simple terms to understand the concept.
The following information will enable you to understand the meaning of this unique term and its importance in auditing.
What it means
To understand what performance materiality means, first take a look at the meaning of auditing.
Auditing is critical to governments, companies, financial institutions, and a range of other businesses. It can be an internal or external process where an independent authority, an auditor, examines a company’s financial statements. The auditor’s responsibility is to collect evidence regarding the fairness and truthfulness of the financial statements and check if they are free of errors and misstatements.
The auditor cannot perform this critical task without using it. But what does this term mean! It is lower than the materiality set by auditors using their professional judgment. It aims to decrease the chances of the aggregate value of the undetected and uncorrected financial statement errors exceeding materiality.
The performance materiality level is impacted by the auditor’s knowledge of the client, along with the types and number of misstatements found in the previous audits of the client.
Many people mistake materiality and performance materiality to be the same thing. While they are closely related, there are a few differences between them.
Materiality is the idea that a single misstatement can affect the ability of the users to make sound financial decisions based on those financial statements. Auditors typically set materiality depending on the needs and expectations of those who use the financial information.
In contrast, performance materiality does not consider a single misstatement’s effect on the users’ ability to make economic decisions. Instead, it thinks an aggregate of misstatements. Auditors set this level depending on the assessment of audit risk.
Why is it so crucial to auditors?
Now that you understand the performance materiality definition, it will be easier to see its high level of fundamental importance in auditing.
Due to its close relation to materiality, it is vital to auditors and helps them avoid audit risks. Using this incredible tool can quickly decrease the risk of giving an incorrect audit opinion. Furthermore, auditors cannot rely solely on materiality as there is a chance of misstatements occurring in immaterial items. Therefore, they use performance materiality as an aggregate measure for intangible things.
Auditors use various factors as a benchmark to set materiality. Then, they set the performance materiality based on the materiality level. To fix these levels, they usually consider vital aspects such as revenues, nature of the business, capital structure, ownership, etc.
Performance Materiality: Conclusion
Reliable auditors will always pay close attention to the misstatements in financial statements and decide likewise. It is a critical tool that helps them reduce the scope of audit errors, enabling them to perform their duties excellently.