Planning materiality is concerned with whether a misstatement, or an aggregation of misstatements, in a financial statement item or an underlying account balance or class of transaction, is likely to result in a material misstatement in the financial statements as a whole. Auditors use planning materiality to determine which items to examine in the various levels of aggregation (i.e. financial statement, account balance and transaction levels). Auditors select for examination those financial statement items, account balances or transactions that equal or exceed the value of planning materiality for the particular level of aggregation[fn].
The starting point for the value of planning materiality is the value of reporting materiality. (As reporting materiality is based on pre-tax income and/or other financial statement items that are unknown and capable only of estimation during the audit planning stage, planning materiality may be based on the estimated value of reporting materiality, rather than the actual value of reporting materiality).
Auditors firstly select for examination those financial statement items that equal or exceed the (estimated) value of reporting materiality. This is because it is only possible for those items to contain a misstatement that equals or exceeds the value of reporting materiality. However, it is possible for a financial statement item that has a value less than the value of reporting materiality to contain a misstatement, which, when aggregated with other misstatements in financial statement items, equals or exceeds the value of reporting materiality. For this reason, auditors also select for examination those financial statement items equal to or greater than a certain amount, but less than the value of reporting materiality. This "certain amount" is referred to as the value of planning materiality at the financial statement level. Auditors refer to financial statement items that equal or exceed this amount, as material financial statement items.
Similarly, auditors initially select for examination those account balances that equal or exceed the value of planning materiality at the financial statement level. This is because it is only possible for those balances to contain a misstatement that equals or exceeds the value of planning materiality at the financial statement level. However, it is possible for an account balance that has a value less than the value of planning materiality at the financial statement level to contain a misstatement, which, when aggregated with other misstatements in other account balances comprising a particular financial statement item, equals or exceeds the value of planning materiality at the financial statement level. For this reason, auditors also select for examination those account balances equal to or greater than a certain amount, but less than the value of planning materiality at the financial statement level. This "certain amount" is referred to as the value of planning materiality at the account balance level. Auditors refer to account balances that equal or exceed this amount, as material account balances.
Finally, it is possible for a transaction that has a value less than the value of planning materiality at the account balance level to contain a misstatement, which, when aggregated with other misstatements in other transactions comprising a particular account balance, equals or exceeds the value of planning materiality at the account balance level. For this reason, auditors also select for examination those classes of transactions that include transactions equal to or greater than a certain amount, but less than the value of planning materiality at the account balance level. This "certain amount" is referred to as the value of planning materiality at the class of transaction. Auditors refer to transactions that equal or exceed this amount, as material transactions.
Planning materiality, unlike reporting materiality, is solely a quantitative concept that is used by the auditor to plan which financial statement items, account balances and (where the audit approach is in-depth) classes of transaction, to select for examination.
| LEVEL OF AGGREGATION | What the value for planning materiality means |
How the value is determined | Practical implications |
|---|---|---|---|
| Financial statement level | Financial statement items less than this value are not likely to contain misstatements that will, when aggregated with misstatements of other financial statement items, equal or exceed the (estimated) value of reporting materiality. | Planning materiality at the financial statement level is evaluated by reference to (i) the (estimated) value of reporting materiality and (ii) the expected nature, number and value of financial statement items included in the financial statements. | It is not unusual for all financial statement items to exceed the value of planning materiality at the financial statement level. |
| Account balance level | Account balances underlying a particular financial statement item that are less than this value are not likely to contain misstatements that will, when aggregated with misstatements of other account balances underlying the financial statement item, equal or exceed the value of planning materiality at the financial statement level. | Planning materiality at the account balance level is evaluated by reference to (i) the value of planning materiality at the financial statement level and (ii) the expected nature, number and value of account balances underlying the financial statement item. | It is not unusual for most account balances comprising a financial statement item to exceed the value of planning materiality at the account balance level. |
| Class of transaction level | Classes of transactions underlying a particular account balance that only comprise transactions less than this value are not likely to contain miss statements that will, when aggregated with misstatements of other transactions in that class, equal or exceed the value of planning materiality at the account balance level. | Planning materiality at the class of transaction level is evaluated by reference to (i) the value of planning materiality at the account balance level and (ii) the expected nature, volume and value of classes of transactions underlying the account balance. | It is not unusual for most classes of transactions to include transactions that exceed the value of materiality at the class of transaction level. Only those transactions in each class that exceed that level are selected for examination. |
Example. The auditor may determine the (estimated) value of reporting materiality for a particular entity, based on expected net after tax income, as $2 million. Based on the expected nature, number and value of financial statement items, the auditor may set planning materiality at the financial statement level at $1 million. Then, based on the expected nature, number and value of account balances underlying financial statement items, the auditor may set the value of planning materiality at the account balance level at $500,000. Finally, based on the expected nature, volume and value of transactions underlying account balances, the auditor may set a value for planning materiality at the class of transaction level at $100,000. This means the auditor will select for examination all financial statement items equal to or exceeding $1 million, all account balances equal to or exceeding $500,000 and, for account balances in which the audit approach is in-depth, all classes of transactions underlying the account balance containing transactions equal to or exceeding $100,000.
Note that because (i) the value of planning materiality includes a consideration of the expected nature of the items, and (ii) the risk of misstatement of the various financial statement items may be different, the value of planning materiality for each financial statement item in the above example may be more or less than $1 million, depending on whether the item has a lower or higher (respectively) risk of misstatement. Similarly, different account balances will have planning materiality values that are more or less than $500,000 and different classes of transactions will have planning materiality values that are more or less than $100,000.
Generally, the greater the number of items/balances/transactions in a particular level of aggregation, the lower is the value of planning materiality for that level of aggregation. Also note that materiality at the class of transaction level is only applicable when the audit approach for a particular account balance assertion is in-depth.
The value of planning materiality is equivalent to the value of the tolerable level of exceptions in the substantive testing of account balances and classes of transactions. (Refer to separate section on Audit sampling and testing procedures).
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