Performance materiality is an amount less than the level of overall materiality, and is reduced in order to allow for the risk that there may be several smaller errors or omissions that have not been identified by the auditor. These smaller items could be material when aggregated, so the performance materiality level is set to accommodate them. Thus, performance materiality reduces the probability that the aggregate amount of uncorrected and undetected misstatements exceeds the materiality level for the financial statements as a whole. The level of performance materiality selected is a matter of professional judgment, and is impacted by the auditor’s understanding of the client, including the types and amounts of misstatements found during previous audits of the client; these matters impact the auditor’s expectations regarding misstatements that might be present in the current period. The level of performance materiality can be set at different levels for different accounts.
This has a direct bearing on sample size, since a greatly reduced level of performance materiality will call for significantly larger sample sizes in order to reduce the risk of accepting a sample when the associated population actually contains a material misstatement.