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Accounting concepts: Materiality

Updated on July 8, 2011
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Accuracy, relevance and reliability are critical characteristics of good accounting information.

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.

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  • ustad profile image

    ustad 

    6 years ago from Pakistan

    Dear Sir!

    a good hub explaining the application of materiality in preparation of financial statements!

    as you stated that the accountant determines the prciseness of information so as to be useful for external users.

    In general purpose financial statements the preciseness of information to be included in financial statements is determined by the Applicable Financial Reporting Framework(obviously a general purpose framework to achieve fair presentation), not by the accountant.

    correct me if im wrong...

    thanks,

working

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