What Is Materiality in Accounting? Definition & Guide

What Is Materiality in Accounting? Definition, Principle, and Examples

Materiality in accounting determines which financial information matters enough to influence the decisions of investors, creditors, and other stakeholders. Misunderstanding this concept leads to cluttered financial statements, audit failures, and regulatory issues. This guide explains the materiality concept, how to calculate materiality thresholds, and real-world applications under IFRS and US GAAP.

Whether you are preparing for professional exams like the ACCA Diploma in IFRS or working through accounting interview questions, mastering materiality is essential.

Watch a song to remember materiality in accounting

Materiality Meaning in Accounting

Materiality refers to the significance of an item based on whether its omission or misstatement could influence the economic decisions of users relying on financial statements. If leaving something out—or getting it wrong—would change how someone interprets the numbers, that item is material.

The IFRS Conceptual Framework defines materiality as entity-specific: what qualifies as material for a multinational bank differs from what matters for a startup. Context, size, and nature all play a role.

Core Characteristics

1. Decision relevance – Affects how users interpret financial health
2. Professional judgement – Requires both quantitative thresholds and qualitative assessment
3. Entity-specific – Varies by company size, industry, and economic environment
4. User-focused – Considers the needs of investors, lenders, and regulators

Understanding materiality helps accountants decide what to record in the double entry system, ensuring only significant transactions receive detailed treatment

Materiality Principle in Accounting

The materiality principle states that financial statements should include all information whose omission or misstatement could reasonably be expected to influence decisions made by primary users. This principle balances completeness against information overload.

Under both IFRS and US GAAP, preparers must exercise judgment to determine what rises to the level of materiality. The principle directly relates to qualitative characteristics such as relevance and faithful representation—concepts covered in detail in the IFRS Conceptual Framework.

Convention of Materiality in Accounting

The convention of materiality is an established accounting practice that allows preparers to ignore immaterial items when preparing financial statements. Rather than recording every small transaction in granular detail, accountants can expense minor items immediately or aggregate similar amounts.

Practical example: A company with 500 million in revenue purchases office supplies for 200. Recording each purchase as a separate asset would add complexity without meaningful benefit. The materiality convention permits expensing such items directly.

This convention improves efficiency but requires consistent application—arbitrary changes in what counts as immaterial can undermine comparability across periods.

How to Determine Materiality: Quantitative Thresholds

Determining materiality involves selecting a benchmark, applying a percentage threshold, and adjusting for qualitative factors.

Common Quantitative Benchmarks

Step-by-Step Calculation

1. Select the appropriate benchmark – For profitable entities, profit before tax is common; for loss-making entities, revenue or assets may be more stable.
2. Apply the percentage – For example, 5% of the profit before tax of 10 million equals 500,000 materiality.
3. Consider qualitative factors – Fraud risk, regulatory sensitivity, management compensation tied to metrics.
4. Document the judgment – Explain why the benchmark and percentage were chosen.

For entities studying financial statement analysis, understanding how materiality is set helps evaluate whether disclosed information is sufficient.

Qualitative Materiality: When Small Numbers Matter

Even amounts below quantitative thresholds can be material if they involve:

• Fraud or illegal acts – Any intentional misstatement is material regardless of size
• Debt covenant breaches – A small error that triggers a covenant violation changes the entire financial picture
• Management compensation – Adjustments affecting bonus calculations attract scrutiny
• Trend reversal – An error that turns a profit into a loss (or vice versa) is inherently significant
• Regulatory compliance – Amounts affecting compliance with capital adequacy or other requirements
• Related party transactions – Transactions with related parties deserve heightened attention

The qualitative dimension explains why materiality is described as requiring professional judgement rather than mechanical calculation.

Materiality Concept in Accounting Under IFRS

IFRS treats materiality as a filter for what information to include in financial statements and related notes.

Key IFRS Standards

Under IFRS, materiality applies to recognition, measurement, presentation, and disclosure. For practical examples of how IFRS standards interact, see the IAS 16 property, plant and equipment guide.

Materiality in Accounting Under US GAAP

US GAAP guidance on materiality is dispersed across the Accounting Standards Codification (ASC) and SEC interpretive releases.

SEC Staff Accounting Bulletin 99 is particularly important because it explicitly states that exclusive reliance on quantitative benchmarks is inappropriate—qualitative factors must always be considered.

Materiality in Auditing: ISA 320 and Performance Materiality

Auditors use materiality to plan and evaluate audit engagements. International Standard on Auditing (ISA) 320 establishes requirements for determining materiality in planning and performing an audit.

Types of Audit Materiality

1. Overall materiality – The threshold for the financial statements as a whole, used to evaluate uncorrected misstatements at the end of the audit
2. Performance materiality – Set lower than overall materiality to reduce the risk that aggregate uncorrected misstatements exceed overall materiality; typically 50–75% of overall materiality
3. Specific materiality – Applied to particular classes of transactions, balances or disclosures where lower thresholds are warranted (for example, related party transactions)
4. Trivial threshold – Amounts below which misstatements are clearly inconsequential; typically 3–5% of overall materiality

Practical Audit Example

An auditor sets overall materiality at 1 million based on 5% of profit before tax. Performance materiality is set at 750,000 (75%). Misstatements below 50,000 (5% of overall materiality) are considered trivial and not accumulated unless qualitatively significant.

For candidates preparing for audit-related exams, the CIA certification guide covers internal audit standards that also reference materiality.

Materiality Concept in Accounting Examples

Example 1: Manufacturing Company

Facts: Revenue of 200 million, profit before tax of 15 million, total assets of 180 million.

Materiality calculation:

• 5% of profit before tax = 750,000
• 0.5% of revenue = 1 million
• 0.5% of total assets = 900,000

Judgement: Auditor selects 750,000 based on profit before tax as the most relevant benchmark for users focused on profitability.

Example 2: Loss-Making Technology Startup

Facts: Revenue of 50 million, loss before tax of 20 million, total assets of 80 million.

Materiality calculation:

• Profit-based benchmark is inappropriate due to volatility
• 0.5% of revenue = 250,000
• 0.5% of total assets = 400,000

Judgement: Auditor selects 300,000, blending revenue and assets to reflect the nature of the business where revenue growth is the primary user focus.

Example 3: Qualitative Override

A bank discovers a 100,000 misstatement—well below its 5 million materiality threshold. However, the error relates to a regulatory capital calculation. Because the misstatement could affect compliance with capital adequacy requirements, it is treated as material despite its quantitative smallness.

Industry-Specific Materiality Considerations

Different industries have unique materiality drivers:

Relationship Between Materiality and Other Accounting Concepts

Materiality and Relevance

Information is relevant if it can influence user decisions. Materiality acts as a threshold—if an item is too small to influence decisions, it is not relevant enough to warrant separate disclosure.

Materiality and Faithful Representation

Even immaterial errors should be corrected if it is practical to do so. However, the cost of identifying and correcting trivial errors may outweigh the benefit. Materiality provides the filter for where to draw that line.

Materiality and the Accrual Concept

The accrual concept requires recognising transactions when they occur, regardless of when cash is received. Materiality interacts with preparers by allowing them to expense immaterial prepayments immediately rather than deferring them.

Materiality and Prudence

Prudence (or conservatism) historically led to asymmetric treatment—being quicker to recognise losses than gains. Materiality ensures that prudence does not result in understating assets or overstating liabilities to an extent that misleads users.

Common Materiality Mistakes and How to Avoid Them

Mistakes

• Over-reliance on quantitative thresholds – Ignoring qualitative factors that make small amounts significant
• Inconsistent application – Changing benchmarks or percentages without justification
• Failing to reassess – Materiality should be reconsidered when circumstances change (for example, a significant acquisition)
• Aggregation errors – Individually immaterial items may be material in aggregate
• Documentation gaps – Failing to record the rationale for materiality judgements

Best Practices

• Use multiple benchmarks as a cross-check
• Document qualitative considerations explicitly
• Reassess materiality at interim reporting dates and year-end
• Track accumulated misstatements throughout the period
• Align with industry norms and peer company practices

Advantages and Disadvantages of Materiality

Advantages

• Reduces clutter – Financial statements focus on what matters
• Improves efficiency – Preparers and auditors allocate resources appropriately
• Enhances relevance – Users receive information that affects decisions
• Supports cost-benefit balance – Avoids excessive disclosure costs for minimal user benefit

Disadvantages

• Subjectivity – Different preparers may reach different conclusions
• Potential for abuse – Management may exploit materiality to obscure unfavourable information
• Inconsistency – Lack of bright-line rules makes cross-company comparison harder
• Complexity – Requires ongoing judgement rather than mechanical application

Future of Materiality in Accounting

Technology Integration

AI-powered tools increasingly assist with materiality assessment by analysing patterns, identifying anomalies andbenchmarking against peers. Real-time dashboards can flag transactions approaching materiality thresholds.

ESG and Sustainability Reporting

Materiality is expanding beyond financial statements into sustainability reporting. The concept of "double materiality"—considering both the entity's financial impact and its impact on society—is gaining traction, particularly in Europe.

Convergence Efforts

Standard-setters continue to refine materiality guidance to improve consistency. The IASB's Practice Statement 2 (Making Materiality Judgements) provides non-mandatory guidance that many preparers find helpful.

Frequently Asked Questions

What is materiality in accounting in simple terms?

Materiality means information is significant enough to affect how users make decisions based on financial statements. If omitting or misstating something would change someone's view, it is material.

How is materiality determined in accounting?

Materiality is determined by selecting a benchmark (such as profit, revenue, or assets), applying a percentage threshold (typically 0.5–5%), and adjusting for qualitative factors such as fraud risk or regulatory impact.

What is the difference between materiality in accounting and auditing?

In accounting, materiality guides what to include in financial statements. In auditing, materiality determines how much evidence to gather and how to evaluate misstatements.

Can materiality change during an audit?

Yes. Auditors should reassess materiality when circumstances change—for example, if actual results differ significantly from planning-stage estimates.

What is performance materiality?

Performance materiality is set lower than overall materiality to reduce the risk that accumulated uncorrected misstatements exceed the overall threshold. It is typically 50–75% of overall materiality.

Learn More with Eduyush

Eduyush offers internationally recognized certifications to help you understand and apply materiality in accounting:

• ACCA Diploma
• CPA Course – US GAAP and auditing standards including materiality
• CIA Certification – Internal audit standards and risk-based materiality

For official technical guidance on materiality and professional judgement, refer to ACCA's resources at accaglobal.com.

Academic research articles on concept of materiality 

1. An Empirical Investigation of the Concept of Materiality in Accounting
   • This paper discusses the implicit role of materiality in every accounting decision, defining it as the relative, quantitative importance of financial information to a user in the context of decision-making. The study highlights that while definitions exist, they must be more operational, emphasizing the challenge of identifying materiality in practice..
2. A Genealogy of Accounting Materiality
   • This paper explores the historical dimensions of materiality, identifying it as a concept shaped by power dynamics and multiple roles, including moral responsibility and risk management. It argues that materiality is malleable and can be reinvented to meet changing priorities and challenges in accounting.
   • (Bolt, 2016).
3. Discussion of an Empirical Investigation of the Concept of Materiality in Accounting
   • This discussion critiques the approach of linking materiality judgments to the sophistication of financial statement users, arguing that materiality should be consistent regardless of the user group. It emphasizes focusing on the objectives of financial statements rather than user capabilities.
4. An Examination of the Perceptions of Auditors and Chief Financial Officers of the Proposed Statement of Financial Accounting Concept Definition of Materiality
   • This study examines the perceptions of auditors and CFOs regarding a proposed new definition of materiality based on the US Supreme Court's definition. It finds that both groups have negative perceptions of the new definition and suggests that materiality should be evaluated from the user's perspective.
   • (Du et al., 2019).
5. Applying the Materiality Concept: The Case of Abnormal Items
   • This research investigates how materiality was applied in the disclosure of abnormal items in Australian financial reports. It finds that a significant portion of disclosed abnormal items were immaterial, thus potentially misleading users.

About the Author: This guide was written by Vijaya Swaminathan, CA, a chartered accountant with 25 years of experience and 15 years specialising in IFRS training and implementation.