Field Notes
Setting Materiality for Trading Companies
Why revenue-based materiality can mislead when margins are thin, and what auditors look at instead.
materiality planning
Trading companies often show large turnover with modest net profit. Using a percentage of revenue alone can set materiality so high that misstatements in inventory or receivables escape notice—or so low that every invoice becomes a testing candidate.
Many engagement teams therefore consider profit before tax, normalised for one-off gains, alongside balance-sheet anchors such as equity or total assets. The choice should reflect how users of the statements make decisions: lenders watching covenant ratios may care more about net assets than about top-line sales.
Performance materiality sits below overall materiality to catch aggregation risk. Finance teams should not treat that figure as a licence to leave known errors uncorrected; known misstatements still need evaluation regardless of size.
Discuss expected materiality in the planning meeting. If your company anticipates a thin year, say so early. Surprises about profitability after fieldwork has begun force late re-scoping and extra sample sizes.
Document the rationale in the engagement file. Clear reasoning helps when a second partner reviews the file or when next year’s team inherits the planning memo.