Determination of Materiality in Planning and Tolerable Error in the Audit of Financial Statements

Based on the planning performed, the auditor determines the amounts from which he will consider that the Financial Statements (FS) are significantly wrong, this is, they contain errors that by their amount (monetary amount) significantly affect the reasonableness of the presented balances.

The ISA 320 Materiality in planning and performing an audit, in paragraph 9, states "the 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”.

This shows that the statements, assertions or disclosures of the Administration or Management of the Entity that have been identified as erroneous, as well as the risk of non-detection by the auditor should be adequately evaluated in this first stage of the audit (Planning), in order to fulfill with the requirements of the Auditing Standards: i) Materiality of the FS as a whole; ii) The materiality of classes, elements, item balances, group of transactions and iii) Amounts below the materiality level (tolerable error). In this way, the Auditor, under his "professional judgment", defines the nature, extent, timing and scope of the audit procedures to be conducted in the second stage of the audit (Execution).

The materiality in planning then will be used to guide the scope of the audit procedures conducted.

For its part, paragraph 5 of ISA 320 requires: “The concept of materiality is applied by the auditor both in planning and performing the audit and in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report”. This means that if the effects of the facts or issues observed (uncertainties and/or limitations on scope) in the audit are "material", it may lead to issue a Disclaimer of Opinion (ISA 700).

Determination of planning materiality (PM) and tolerable error (TE)

Company Name	“ABC”	“YNGH”
Assets	40,000,035	217,064,791
Revenues	21,122,559	195,148,862
Percentage	0.50%  (*)	0.25%
Planned Materiality	105,612.80	542,662
Tolerable Error (50% materiality)	52,806.40	271,331

(*) The higher the risk, it will be applied the lower percentage, which could be from 0.25% to 3% of the selected base. For example, the fact that in the prior audit to the Financial Statements has been issued a disclaimer of opinion should be considered a high risk and consequently a lower percentage to determine the Planning Materiality.

It can have other bases of measurement, this will depend on the information gathering, control tests and knowledge of the business, ie, according to particular circumstances to determine the relative importance (materiality).

Prepared by: José Luis Giráldez Condori

CERTIFIED PUBLIC ACCOUNTANT

Lima – Perú

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