Materiality

What it means

Materiality is the threshold above which information would change a user’s decision about the financial statements. It decides what must be shown separately and what may be aggregated.

It is not merely a percentage of turnover. A small amount can be material if it concerns a related party, directors’ pay or something that changes the picture of the company.

Materiality is also judged in aggregate. Ten small errors, none of them material on its own, can be material together if they distort the same line item or push the profit or loss in the same direction. That is why differences found are collected rather than assessed one by one.

How it works in practice

In practice it saves time: there is no point splitting trivial accruals to the cent when nothing changes. The point is to concentrate on items that move the result or the balance sheet.

In an audit the auditor sets materiality numerically and uses it for sampling and for judging misstatements. The company then knows what to expect and where precision matters most.

When we find an error from the previous year while closing the books, materiality decides how it is corrected. An immaterial one we fix with a correcting entry in the current period, a material one through the retained-results account with no effect on this year’s result and with a description in the notes.

What to watch out for

Materiality is no excuse for omitting inconvenient information. Litigation, a guarantee or dependence on a single customer belong in the notes regardless of amount.

It makes sense to record the materiality threshold for routine decisions, such as accruing small amounts, in an internal accounting policy. Without it each case is decided ad hoc, the same items are treated differently in different years, and in an audit this looks like deliberate management of the result.