Accounting ideas: Materiality
Accuracy, relevance and reliability are critical characteristics of good accounting
The concept of materiality helps to reinforce those characteristics by classifying
financial information’s usefulness to its users.
As such, materiality is a subjective concept. Whether financial data is material or not
depends not just on its users but on its purpose.
Material information defined as anything that influences the economic decisions of
financial report users. In other words, materiality equates to importance or significance
and pertains to financial data, transactions and even errors.
For example, if the value of an asset is $1,000.00, but it is entered in the books as
$1000.09, that is an immaterial error, since it's not significant enough to affect the
decisions of those who are reading the information. The true test of whether information
is material or immaterial is the answer to a basic question: “Would the omission or
inaccurate reporting of this information affect its users?”
Given the wide range of external information users, accountants should have an idea on
how precise information needs to be. Some external users of financial reports include
government, regulators, lenders, suppliers and the public. Therefore, accountants need to
consider just how accurate information needs to be. It may not be necessary to have
information accurate to the nearest cent or dollar.
Unfortunately, establishing materiality is far from an exact science. Preparers of financial
statements typically use rules-of-thumb or guidelines to determine what to include or
omit and how precise included information needs to be. After all, minor errors can be
major depending on the context. The principles of prudence and fair representation can
be affected by the materiality concept.
Recall that financial reports are summarized data. Therefore, materiality may require the
aggregation of data. For example various overheads associated with a cost centre may be
summarized. Within those overheads, there may be a subheading for “sundry expenses”
as well. As such, the concept of materiality affects how accounts are prepared.
Context is also important to materiality as is financial accuracy. For instance, errors of
omission are material, even though they may cancel each other out. Although the error
might not affect the balancing of ledger accounts or the Statement of Financial Position,
it may not properly reflect the transactions and events that occurred.
The concept of materiality gives a guideline for information accuracy. It also reinforces
other accounting concepts, such as fair presentation, and characteristics of financial
statements – like accuracy. Materiality ensures that information is sufficiently precise
without including unnecessary detail.