Definition
Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements (IASB Framework).
Materiality therefore relates to the significance of transactions, balances and errors contained in the financial statements. Materiality defines the threshold or cutoff point after which financial information becomes relevant to the decision making needs of the users. Information contained in the financial statements must therefore be complete in all material respects in order for them to present a true and fair view of the affairs of the entity.
Materiality is relative to the size and particular circumstances of individual companies.
Example - Size
A default by a customer who owes only $1000 to a company having net assets of worth $10 million is immaterial to the financial statements of the company.
However, if the amount of default was, say, $2 million, the information would have been material to the financial statements omission of which could cause users to make incorrect business decisions.
Example - Nature
If a company is planning to curtail its operations in a geographic segment which has traditionally been a major source of revenue for the company in the past, then this information should be disclosed in the financial statements as it is by its nature material to understanding the entity’s scope of operations in the future.
Materiality is also linked closely to other accounting concepts and principles:
- Relevance: Material information influences the economic decisions of the users and is therefore relevant to their needs.
- Reliability: Omission or mistatement of an important piece of information impairs users’ ability to make correct decisions taken on the basis of financial statements thereby affecting the reliability of information.
- Completeness: Information contained in the financial statements must be complete in all material respects in order to present a true and fair view of the affairs of the company.
Quiz
How much do you know about materiality concept?
Take the free quiz below and find out!
Question
ABC LTD has a yearly turnover of $100 million. Which of the following information is material to the users of its financial statements?
ABC LTD has been sued by XYZ LTD for $10 million as damages for breach of contract. The decision of the Court is still pending.
Correct.
The nature of the litigation must be disclosed in the financial statements as it may significantly impact company's future profitability.
ABC LTD sold goods worth $1 million to its subsidiary DEF LTD.
Correct.
Although sales to DEF LTD represent only 1% of total sales of ABC LTD, the information regarding transaction with a related party is material by nature as it may help users to determine the impact of such transactions on the performance of the entity.
ABC LTD does not disclose details of its operating lease in respect of an office space rented at $10,000 per annum.
Incorrect.
The disclosure regarding details of the operating lease worth only $10,000 per annum is unlikely to influence the economic decisions of users of ABC LTD's financial statements.