The materiality concept of accounting is an accounting convention that refers the relative importance or significance of an item to an informed decision-maker. The materiality concept of accounting guides the recognition of a transaction. It means that transactions of little importance should not be recorded. A transaction may be recorded, but its relevance and significance should be kept in mind. For example, a newly purchased pencil is an asset of the business. Whenever the pencil is used, a part of the asset is consumed. Although the pencil may still be available at the end of the year, its original cost is insignificant, and so it would be a waste of time to include it in closing stock. Therefore, it is written as an expense for the period in which it was purchased. As this example illustrates, the materiality concept of accounting encourages accountants to ignore other accounting concepts in relation to items that are not material. There are no hard and fast rules one can apply to determine the materiality of an item. However, factors such as the size of a business can be used as the basis for deciding on the materiality of any transaction. While the matching and accrual concepts require an accountant to accurately calculate the exact cost to charge to the income statement for a specific period, the materiality concept states that this should be done only to the extent that the item is material. The spirit of the principle is that unnecessary details should be avoided because the cost of going into such details is often greater than the benefit of the exercise. Suppose a box is purchased for $5. It will probably last for 5 years. It would be tedious, time-consuming, expensive, and generally inconvenient to treat a box costing $5 as a fixed asset and depreciate it over five years using the straight-line method. It would be easier to classify the entire cost of $5 as an expense for the year in which the box was purchased. It would not materially misstate the profit for that year (or the remaining four years). It is difficult to set a limit as to what is material, as this would differ from organization to organization. For large multinational companies, an expense of $200 may be too small to capitalize, while a retail shop might consider assets costing $200 large enough to be treated as an asset rather than an expense. Most companies have internal rules about such limits. Once such rules or limits are set, they should be consistently applied.Materiality Concept: Definition
Materiality Concept: Explanation
Example of Materiality Concept of Accounting
Materiality Concept of Accounting FAQs
According to the principle of materiality, no single transaction or event, however significant it might appear on the surface, is so important as to be considered irrelevant for purposes of reporting. It has been held that no amount can be disregarded if it affects a company's operations and income enough to change its management's decisions.
As far as recording or reporting are concerned, what appears to be immaterial in terms of cash transactions may eventually prove to be important when examining a company's record keeping. This is especially true when many transactions are involved.
If an item is immaterial, the accountant doesn't need to record it in the books. For example, if a company owns an asset worth $1 million that will become obsolete next year and have to be disposed off at a loss, it does not have to show this in its balance sheet.
Since inventories are an essential part of business accounting, it is not advisable to apply the materiality concept. Thus, even if something is immaterial in terms of quantities or value, they might be important for making business decisions. For example, if the cost is very low, a company can buy more inventory, which may result in additional sales and earnings.
According to the principle of materiality, no single transaction or event, however significant it might appear on the surface, is so important as to be considered irrelevant for purposes of reporting. It has been held that no amount can be disregarded if it affects a company's operations and income enough to change its management's decisions.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
