Materiality-Definition,Explanation,Examples (Commerce Achiever)

In accounting, materiality refers to the impact of an omission or misstatementof information in a company’s financial statements on the user of those statements. If it is probable that users of the financial statements would have altered their actions if the information had not been omitted or misstated, then the item is considered to be material. If users would not have altered their actions, then the omission or misstatement is said to be immaterial.

The materiality concept is used frequently in accounting, especially in the following instances:

• Application of accounting standards. A company need not apply the requirements of an accounting standard if such inaction is immaterial to the financial statements.

• Minor transactions. A controller who is closing the books for an accounting period can ignore minor journal entries if doing so will have an immaterial impact on the financial statements.

• Capitalization limit . A company can charge expenditures to expense that would normally be capitalized and depriciated over time, because the expenditures are too small to be worth the tracking effort, and capitalization would have an immaterial impact on the financial statements.

Thus, materiality allows a company to ignore selected accounting standards, while also improving the efficiency of accounting activities.

The dividing line between materiality and immateriality has never been precisely defined; there are no guidelines in the accounting standards. However, a lengthy discussion of the concept has been issued by the Securities and Exchange Commision in one of its Staff Accounting Bulletins; the SEC’s comments only apply to publicly-held companies.

Examples of Materiality

Here are several examples of materiality in accounting information:

• A company encounters an accounting error that will require retrospective application, but the amount is so small that altering prior financial statements will have no impact on the readers of those statements.

• A controller could wait to receive all supplier invoices before closing the books, but instead elects to accrue an estimate of invoices yet to be received in order to close the books more quickly; the accrual is likely to be somewhat inaccurate, but the variance from the actual amount will not be material.

• A company could capitalize a tablet computer, but the cost falls below the corporate capitalization limit, so the computer is charged to Office supplies expense instead.