What does overall materiality mean on the CPA exam?
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Overall materiality. Materiality for the statements as a whole, set during planning. Performance materiality is set below it so that undetected errors cannot add up past it.
Defined against AU-C 320.10.
Worked example
A firm's policy for profitable private companies is overall materiality at 5% of normalized pretax income and performance materiality at 70% of that figure. This year a client reports pretax income of $6,800,000, which includes an $800,000 one-time gain on the sale of its old headquarters.
What overall materiality and performance materiality does the auditor set?
| Normalized pretax income, removing the one-time gain6,800,000 - 800,000 | 6,000,000 |
| Overall materiality6,000,000 x 5% | 300,000 |
| Performance materiality300,000 x 70% | 210,000 |
Answer: Overall materiality of $300,000 and performance materiality of $210,000. Both percentages are the firm's policy and the auditor's judgment; the standard prescribes neither.
The trap: Applying 5% to reported pretax income, which gives $340,000 and lets a nonrecurring gain loosen the whole audit. A benchmark should reflect what users rely on year to year, so unusual items come out first.
Based on AU-C 320.10; AU-C 320.11.
Which CPA exam sections use overall materiality?
Overall materiality appears in the AUD section of the CPA exam.
Other terms defined against AU-C 320
- material misstatement: An error or omission in the financial statements large enough, or of a kind, that it could change the decision of a reasonable user relying on them.
Related terms
- component materiality: Materiality set for one part of a group, below group materiality, so that undetected errors across several components cannot add up past the group threshold.
- tolerable misstatement: A monetary amount set so that the risk of the actual misstatement in the population exceeding it is acceptably low.
- present fairly: The overall judgment behind an opinion: the statements as a whole give a true picture within the applicable framework, beyond mere technical compliance with each rule.