What does tolerable misstatement mean on the CPA exam?
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Tolerable misstatement. A monetary amount set so that the risk of the actual misstatement in the population exceeding it is acceptably low. It is performance materiality applied to one sampling procedure, not a separate judgment about the statements as a whole.
Defined against AU-C 530.05, .A6.
Worked example
Performance materiality is $240,000, and the auditor sets tolerable misstatement for a confirmation test of trade receivables at $200,000. The population is $6,400,000. The sampled balances total $800,000 and contain $12,000 of overstatement, which the auditor projects to the population in proportion to book value. The sample was sized expecting about $100,000 of misstatement in the population.
What is the total projected misstatement, and does the sample support the balance?
| Rate of misstatement in the sample12,000 / 800,000 | 0.015 |
| Projected misstatement in the population0.015 x 6,400,000 | 96,000 |
| Room left below tolerable misstatement for sampling risk200,000 - 96,000 | 104,000 |
Answer: Projected misstatement is $96,000, well below the $200,000 tolerable misstatement, and below the $100,000 the sample was sized to expect, so the sample supports the balance unless other evidence points the other way. The $96,000 is accumulated as a projected misstatement.
The trap: Comparing the $12,000 actually found with the tolerable amount. Only the sampled items were examined, so the finding has to be projected to the whole population before it means anything; a projection close to the tolerable amount would leave too little room for sampling risk.
Based on AU-C 530.05; AU-C 450.A6.
Which CPA exam sections use tolerable misstatement?
Tolerable misstatement appears in the AUD section of the CPA exam.
What is the difference between tolerable misstatement and performance materiality?
The standards relate them in one sentence and then insist they be kept apart. Performance materiality is set below materiality for the financial statements as a whole, and additionally below any lower materiality the auditor has set for particular classes of transactions, account balances or disclosures. Tolerable misstatement is “the application of performance materiality to a particular sampling procedure”, and it attaches to the population being sampled rather than to the sample itself. AU-C 320 ends its own definition by saying performance materiality is to be distinguished from tolerable misstatement. The mistake candidates make is assuming tolerable misstatement must be smaller: it may be the same amount. (AU-C 320.09 and AU-C 530.A6)
Other terms defined against AU-C 530
- audit sampling: Selecting and evaluating less than 100% of a population of audit relevance so the sample is expected to be representative, giving a reasonable basis for conclusions about the whole population.
Related terms
- 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.
- overall materiality: Materiality for the statements as a whole, set during planning.
- nature, timing, and extent: The three dials on any audit procedure: what kind of test, when it is run, and how much of the population it covers.
- 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.
- assessed risk: The auditor's judgment about the risk of material misstatement at the assertion level, combining inherent and control risk.
- risk of material misstatement: The risk that the statements are materially misstated before the audit begins.