Final answer:
Planning materiality is the threshold for judging misstatements in an audit, setting the scope of what's considered material. Performance materiality is lower than planning materiality, acting as a buffer to catch misstatements that might collectively exceed the materiality threshold. Performance materiality thereby mitigates the risk of the financial statements being materially misstated.
Step-by-step explanation:
The relationship between planning materiality and performance materiality is fundamental in the context of an audit. Planning materiality refers to the maximum amount by which the auditor believes the financial statements can be misstated without affecting the decisions of the users of those financial statements. It sets the overall scope for what is considered material in the context of the audit.
Performance materiality, on the other hand, is a proportion of planning materiality and is used to reduce the risk that the aggregate of undetected and uncorrected misstatements exceeds planning materiality. It is the threshold for the auditor to determine whether any identified misstatements are material individually or in aggregate and whether the financial statements overall are materially misstated.
Thus, while planning materiality is the benchmark for judging the materiality of misstatements, performance materiality is the operational threshold that guides the auditor's judgment in evaluating the results of the audit and deciding when adjustments need to be made. It essentially acts as a safety margin beneath the planning materiality level.