Materiality concept in accounting. Definition. Uses

by Vanessa Bowers

Materiality concept in accounting. Materiality is one of the fundamental qualitative characteristics of financial statements. This article will discuss the definition of materiality and explain how accountants use this concept to make informed decisions about financial statements.

Definition of materiality

An item is regarded as material if its omission or misstatement is likely to change the perception or understanding of the users of that information.

On the other hand, an error that is too trivial to affect anyone's understanding of the accounts is considered immaterial. 

Materiality is simply a measure of how important that information is to users.

For example, consider if the bank balance of a large entity is misstated by $1 in the statement of financial position. This item is immaterial and may not be regarded as a material misstatement that would impact the financial information on the balance sheet.

However, suppose the bank balance was misstated by $100,000. In that case, this is more likely to be regarded as a material misstatement as it significantly impacts the financial statements.

How is materiality relevant in accounting

In accounting, the materiality concept is relevant in two situations:

  • when considering whether an item should be disclosed in the financial statements and
  • when making decisions about classifying an item as an expense or an investment. 

The purpose of the materiality concept is to ensure that financial statements are accurate and provide meaningful information to users. 

Generally, items must meet a certain threshold before they are considered material and affect the financial statements.

 Accountants consider quantitative and qualitative factors in determining if an item is material. 

  • Quantitative factors: measure net income, revenue, profit, total assets, and cash flows. Usually, a 1% threshold is applied to determine quantitative materiality.
  • Qualitative factors – related party transactions, unusual transactions, geography, and broader economic uncertainty.

 

Relation with other accounting principles

Relevance:  Information is relevant if:

  • it can influence the economic decisions of users, and
  • is provided in time to influence those decisions. 

Materiality has a direct impact on the relevance of information.

Free from error

The accounting information must be free from error within the bounds of materiality. A material error or an omission can cause the financial statements to be false or misleading.

Examples of uses in materiality in accounting standards under IFRS

IAS 1 requires disclosure of line items in the financial statements based on materiality.

IAS 8:  Change in accounting estimate. The materiality of the changes is also relevant. The nature and amount of a change in accounting estimate that has a material effect in the current period should be disclosed. This fact should also be disclosed if it is impossible to quantify the amount.

IAS 24: Even if the amounts are immaterial. A company must disclose any transactions with the directors or relatives. 

Impairment of assets: IAS 36: Every entity needs to assess for indicators of impairment of assets at every reporting period. The concept of materiality applies, and only material impairment needs to be identified.

Closing comments: 

The materiality principle is a key consideration in financial accounting. The materiality principle holds that financial statements should be prepared and presented so that they fairly represent the economic substance of transactions and events