Materiality in auditing: why auditors do not check every single euro

One of the most important concepts in statutory auditing is also one of the least intuitive: the auditor does not check every single euro recorded by a business. Doing so would be neither efficient nor necessary. The purpose of an audit is to obtain reasonable assurance that the financial statements, taken as a whole, are free from material misstatement, meaning errors capable of influencing the decisions of those using those statements. This is the basis of materiality. The relevant standard is ISA Italia 320: Materiality in Planning and Performing an Audit, which requires the auditor to determine materiality for the financial statements as a whole and, where necessary, specific levels for particular classes of transactions, account balances or disclosures. This requires professional judgement and cannot be reduced to an automatic formula applicable to every business.

What “material” really means

A misstatement is material when, individually or together with other misstatements, it could reasonably influence the economic decisions of users of the financial statements. This means that materiality depends on both the quantitative size of the misstatement and, in some cases, its qualitative nature. An error of 500 euros in a business with turnover of 50 million may be entirely immaterial. The same amount, however, may become more important if it involves, for example, fraud, a related-party transaction or an item receiving particular regulatory attention. The auditor therefore asks not only “How much is the error worth?” but also “What does it concern, and could it change how the financial statements are interpreted?”

Why checking everything would make no sense

Imagine a company that records 100,000 invoices during the year, along with thousands of bank transactions, wages, taxes, purchases, sales and adjusting entries. Checking every transaction in full would require an enormous amount of work without necessarily improving audit quality. Auditing instead uses a risk-based approach. The auditor identifies the areas in which material misstatements are most likely and concentrates more procedures there. ISA Italia 315 specifically addresses identifying and assessing risks of material misstatement, while ISA Italia 330 concerns the procedures the auditor must design in response to the identified risks. Materiality therefore turns an enormous universe of accounting data into a targeted work plan.

How materiality is determined

ISA Italia 320 does not prescribe a universal percentage. Determining materiality requires selecting a benchmark, meaning a reference measure, and an appropriate percentage. Depending on the circumstances, the measures considered may include:

• profit before tax;
• revenue;
• total assets;
• equity;
• total expenses.

The choice depends on the nature of the business and the information most relevant to users of its financial statements. ISA Italia 320 itself provides an example: for a profit-oriented manufacturing business, the auditor may consider 5% of profit before tax appropriate in certain circumstances, whereas for a not-for-profit entity 1% of revenue or total expenses may be more appropriate. However, the standard expressly states that higher or lower percentages may be appropriate depending on the circumstances. This example must therefore not be turned into a mandatory formula. Suppose a company normally earns profits of between 400,000 and 500,000 euros. Profit before tax may be a reasonable benchmark. But imagine that, in the year being audited, profit temporarily falls to 20,000 euros because of an exceptional event. Rigidly applying 5% would produce materiality of just 1,000 euros, probably inconsistent with the size of the business.

In such a situation, the auditor may consider other, more stable benchmarks, such as revenue, assets or normalised profit, using professional judgement. ISA Italia 320 expressly notes that when profit before tax is consistently nominal or unrepresentative, another benchmark may be more relevant. Materiality is therefore not a mechanical calculation. It is a professional decision that must be justified and documented.

Overall materiality and performance materiality

A fundamental distinction now comes into play. Materiality for the financial statements as a whole is the level against which the auditor assesses whether aggregate misstatements could influence users. However, to carry out the actual tests, the auditor also determines performance materiality. Performance materiality is lower than overall materiality and is used to reduce the risk that the aggregate of undetected misstatements and detected but uncorrected misstatements exceeds materiality for the financial statements as a whole. ISA Italia 320 explains that planning the work solely to identify individual misstatements exceeding overall materiality would be insufficient, because many smaller misstatements could add up to a material amount. Suppose overall materiality is:

100,000 euros. Based on professional judgement and engagement risk, the auditor might set performance materiality at: 75,000 euros. A figure of 75% may be adopted within a professional methodology, but it is important to clarify that this is not a percentage required by ISA Italia 320. The standard does not state that performance materiality must always equal 75%. The percentage must be determined by considering factors such as misstatements found in previous years, the quality of internal control and the likelihood of undetected misstatements. For a business with very orderly accounts and few historical errors, the auditor might use a different ratio from that used for a business where numerous adjustments were identified in previous years.

Returning to the example: overall materiality is 100,000 euros. If the auditor designed every test directly around the 100,000 euro threshold, several errors of 30,000 or 40,000 euros might remain undetected even though their total would exceed the limit. Using a more cautious performance threshold instead means designing procedures with a margin of safety. This is the fundamental idea behind performance materiality: allowing room for misstatements that may exist but remain undetected during the audit.

Clearly trivial misstatements

There is also a lower level, often called the threshold for clearly trivial misstatements. ISA Italia 450, which addresses the evaluation of misstatements identified during the audit, requires the auditor to accumulate identified misstatements other than those that are clearly trivial. Clearly trivial misstatements are of a wholly different order of magnitude from immaterial misstatements and are inconsequential in terms of size, nature and circumstances. If there is uncertainty about whether a misstatement is clearly trivial, it must be accumulated: the monetary threshold does not replace that assessment. Suppose, again purely as an example, that overall materiality is 100,000 euros and the methodology adopted sets a clearly trivial threshold of 10,000 euros.

Precision is needed here too: 10% is not a mandatory percentage prescribed by the ISA Italia standards. It is one possible methodological choice, which must remain consistent with professional judgement and the circumstances of the engagement.

Three different levels

Materiality affects sampling

One of the most practical consequences concerns the number and size of transactions to be checked. Suppose trade receivables amount to 2 million euros. If performance materiality is relatively high and internal control is reliable, the auditor may design a particular level of sampling. If materiality is much lower, however, or the risk associated with receivables is high, a larger sample or more extensive procedures may be needed. ISA Italia 530 specifically addresses audit sampling and is closely linked to risk and materiality assessments. Materiality therefore has practical effects on the work performed. However, it is incorrect to interpret materiality as a minimum threshold for selecting invoices.

If performance materiality is 75,000 euros, this does not mean that the auditor checks only invoices exceeding 75,000 euros. An invoice for 10,000 euros may be included in a statistical or non-statistical sample. Many small invoices together may constitute an extremely significant population. A small transaction may also be selected because it has unusual characteristics. The threshold therefore does not represent a “minimum invoice amount to check”. It helps design the entire audit strategy.

Qualitative factors can make a small misstatement material

Materiality is not solely quantitative. Imagine identifying a relatively modest payment to a company connected with a director that has not been properly presented among related-party transactions. The amount may be below overall materiality, but the nature of the transaction can nevertheless make it relevant. ISA Italia 320 recognises that, for particular classes of transactions, account balances or disclosures, misstatements below overall materiality may still influence users’ decisions. Examples mentioned in the standard include related-party transactions and certain particularly sensitive disclosures. This is why auditing cannot be entrusted solely to an Excel formula. The auditor may therefore determine lower materiality levels for particular areas. Suppose a business has overall materiality of 100,000 euros. There may be information for which even a misstatement of 30,000 euros would matter to users. For example:

• directors’ remuneration;
• related-party transactions;
• certain bank covenants;
• legally required disclosures;
• particular areas relevant to the industry.

In these cases, specific materiality lower than overall financial statement materiality may be used.

The relationship with audit risk

Materiality and risk are closely connected. If the risk of material misstatement in an area is high, the auditor must design more robust procedures. Suppose inventory represents 60% of assets and the business has historically struggled to count and value it. This area will be considered much riskier than a straightforward, easily verified balance. Even with the same materiality, work on inventory will therefore be more intensive. This demonstrates that there is no relationship of the following kind:

considered in isolation. The actual relationship is:

A misstatement below the threshold can be added to others

Suppose the following misstatements are identified during the audit:

• overstated receivables: 25,000 euros;
• overstated inventory: 20,000 euros;
• unrecorded liabilities: 30,000 euros;
• insufficient depreciation: 15,000 euros.

No individual misstatement exceeds overall materiality of 100,000 euros. But the total is:

If a further misstatement of 20,000 euros were identified, the total would reach 110,000 euros. ISA Italia 450 specifically requires the auditor to evaluate identified misstatements individually and in aggregate before reaching a conclusion on the financial statements. The threshold cannot therefore be used to systematically ignore all smaller differences. Care is also needed here. Suppose one asset is overstated by 60,000 euros and another understated by 60,000 euros. Mathematically, the overall effect on total assets might cancel out. But the auditor should not automatically conclude that there is no problem. The two misstatements may concern different items and result in a qualitatively incorrect presentation of the financial statements. They may also affect profit or loss, financial ratios or information used by banks and other stakeholders differently. Evaluating misstatements therefore requires professional judgement in this case too.

Materiality may change during the audit

The amount initially determined is not necessarily fixed. Suppose planning is based on forecast profit before tax of 1 million euros. During the year, however, the business experiences a crisis and final profit falls to 200,000 euros. The original benchmark may no longer be appropriate. ISA Italia 320 requires the auditor to revise materiality when information becomes known during the audit that would have led to a different amount being determined initially. Materiality must therefore be updated when conditions change.

The effect on the final stage

At the end of the work, the auditor compares uncorrected misstatements with materiality and assesses whether the financial statements can still be considered reliable in all material respects. Suppose overall materiality is 100,000 euros and uncorrected misstatements of 20,000 euros remain. On a purely quantitative basis, the amount is far below the threshold, although qualitative factors must still be assessed. If the remaining misstatements were 150,000 euros, the issue would be much more significant. At that point, the auditor may ask the company to correct the financial statements. If no correction is made, the auditor must assess the implications for the audit report. Materiality therefore accompanies the engagement from planning through to the final opinion. Professional practice may use recurring methodological criteria, such as percentages of profit, revenue, assets or equity.

This is useful for maintaining consistency between engagements, but it must not become automatic. ISA Italia 320 is very clear: selecting the benchmark and percentage involves exercising professional judgement. A property company, a startup, a mature industrial company and a foundation cannot necessarily be assessed using the same benchmark. The number must reflect how users actually read those financial statements.

A complete example

Suppose a company has:

• revenue: 8,000,000 euros;
• profit before tax: 400,000 euros;
• total assets: 6,000,000 euros.

For illustration only, the auditor might choose profit before tax as the benchmark and apply 5%:

Overall materiality: 20,000 euros. Subsequently, based on risk and historical misstatements, the auditor might set performance materiality at 15,000 euros. A clearly trivial threshold of 2,000 euros might also be used. This would produce a structure such as:

But these figures do not derive from mandatory percentages. The auditor must verify that they are appropriate for that particular business and document the reasons for the choices made. At first glance, materiality might appear to allow the auditor to “tolerate errors”. In reality, it serves the opposite purpose: it focuses limited resources on areas capable of genuinely undermining the reliability of the financial statements. Checking thousands of differences of a few cents would take time away from analysing doubtful receivables, overstated inventories, unrecorded liabilities, related-party transactions or important estimates. The audit must be designed to identify what may influence users of the financial statements. That is the economic purpose of materiality.

Materiality does not mean tolerating fraud

One final point is essential. It would be wrong to conclude that fraud below the threshold is automatically acceptable. The intentional nature of a misstatement can profoundly change its assessment. Deliberate manipulation, even involving a relatively small amount, may indicate problems with management integrity, weaknesses in internal control or the possibility of further undetected misstatements. Qualitative factors therefore become fundamental. Materiality is not a licence to ignore misconduct below a certain amount.

Conclusion

Materiality explains why the auditor does not check every single euro. The purpose of an audit is not to demonstrate that the accounting records are mathematically perfect in every detail, but to obtain reasonable assurance that the financial statements as a whole contain no misstatements important enough to influence their users’ decisions. To achieve this, the auditor determines overall materiality, uses a more cautious performance materiality when designing tests and identifies a threshold below which certain misstatements may be considered clearly trivial. But none of these amounts should be applied mechanically. The question is not “How much error is allowed?” The correct question is “What level of misstatement could materially change the interpretation of these particular financial statements, and how should I design the audit to adequately reduce the risk of failing to detect it?” This is the logic of materiality. And this is precisely why professional auditing is not about checking as many documents as possible, but about examining what truly matters in greater depth.

Note: this content is educational and does not replace a professional assessment of the specific circumstances. The amounts and percentages in the examples are hypothetical. The 75% and 10% illustrate methodological choices and are not percentages required by the ISA Italia standards.