Planning materiality basically refers to the misstatement amount set by auditors at the planning stage of an audit based on the materiality to financial statements.
Planning materiality used by the auditor to assess whether the misstatement as individual or aggregate materially misstated in the financial statements.
And those misstatements could be misleading the users who use the financial information to make the incorrect decision.
Auditors, as required by international standards on auditing, require to assess the materiality of the financial statements at the planning stage. This is normally done by using the combination of both the quantitative method and qualitative method.
Once the auditor identifies and assesses the financial statements’ materiality, then the auditor sets the performance materiality (tolerable misstatement) of financial statements. Planning materiality must be larger than performance materiality.
This is because the planning materiality is the materiality amount to financial statements and performance materiality is the possible misstatements that expected to have happened in the financial statements alone or combine. The following are quantitative factors used to calculate planning material.
- 0.5% to 1% of Sales Revenue
- 1% to 2% of Total Assets
- 1% to 2% of Gross profit
- 2% to 5% of Shareholders Equity
- 5% to 10% of Net Profit
In calculating planning materiality, the auditor might be taking the highest amount from the above factors. For example, higher sales revenue or total assets.
However, the auditor also needs to understand the qualitative factor of materiality in the financial statements of the entity before concluding the size of planning materiality of financial statements.
Example and calculation:
For example, as per the extract from entity financial statements, total assets amount USD 1,000K and total revenues amount USD 500K.
Based on auditor understanding related to the possible risks that could possibly happen, the auditor decides to choose 0.8% of total sales revenue as materiality. Based on this, we get USD 4K as the planning materiality of financial statements.
This 4K planning materiality is the amount that set by the auditor to assess the materiality to the financial statements during their audit If misstatement is found and the amount is equal to or higher than this, adjustment is required.
By using the 4K of planning materiality, we can calculate performance materiality (tolerable misstatements) to financial statements.
As mention above, the auditor needs to set the performance materiality to less than financial statements’ materiality or planning materiality. It is normally calculated by setting the percentage of planning materiality. Let say from 50% to 80% for the financial statements that have fewer risks to financial statements.
However, for financial statements that have high risks of misstatement, the performance materiality is normally low percentages of planning materiality. In such a case, auditors rank from 20% or 30% something.
Planning material is the materiality to financial statements that auditors set in the planning stages. This is the same as the materiality concept in the context of the financial statement.
Any misstatements or omission that reach planning materiality level required adjustment to ensure that the financial statements are true and fair.
Written by Sinra