Materiality is one of the main accounting principles and has a vast effect in the preparation of the financial statements. In order to judge whether the information is material or not, one has to judge its effect over the financial statements if it is not included. It means that materiality is something which can alter the decision of the users of the financial statements.
Omission or misstatement often causes the problems of materiality which may affect the decision taken over the information available
Examples
Materiality concept can be analyzed under two situations:
Size of the transaction – If the transaction amount is material, then its non disclosure could lead the decision makers in doing the wrong decision. For example, if one of the customer of the company owe $2,000 to the company which has net assets of $12 million. Then, the amount of $2,000 is immaterial under the circumstances.
However, If the total assets of the company are $7,000, then $2,000 is material in this case.
Nature of the event – Alpha industry operates in a country which is going to apply a new legislative law. This would impair the operations in the country for Alpha industry. Though, there is no figures involved here but Alpha has to write this information in the financial statements to help the user in making the right decisions.
More Examples
3TL is engaged in manufacturing steel utensils. There are some transactions which need your guidance as management accountant:
- Total accounts receivable of 3TL reported on the balance sheet date 31 Dec, 2016 is $ 50 million. On 25th January 2017, one of its debtors went into liquidation amounting to $7 millions. The date of issue of financial statement is 31st March, 2017.
- Due to electric short circuit, company building got damaged. After inquiry from the insurance company, 3TL has to bear a loss of $1,000. The total net assets of the company are $1000 millions.
- Junior accountant is doubtful and unclear about which head to charge certain expenses amounting to $1600. In this confusion, he charged these expenses in miscellaneous expenses. Total revenue of the company is $50,000.
Solution
- Accounts receivable are properly handled by creating a 2 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} allowance for doubtful debt. The limit is set by considering numerous factors in calculation. If a minor debtor gets bankrupt, then there is no need to amend financial statements. But, as in this case the amount is $7 million which is material and significant to the total value of the account receivable. 3TL need to amend its financial statement asnd the value of bad debt expenses.
- The net assets of the company are far more than the loss of $ 1,000 which 3TL has to bear. So, this amount is immaterial. There is no need to amend the financial statement as this could not lead the decision makers/ users in making the wrong decisions.
- It is always good to properly account for the expenses in relevant head. This enables the decision maker in drawing appropriate strategy. However, there is a need to consider the amount of materiality in this example. As the amount is very small as compared to the total revenue figure, there is no need to work further in classifying the expenses in appropriate heads. Even classification is done; no benefit can be obtained from such exercise.