Characteristics of Materiality principle

Characteristics of Materiality Principle

In this article, we would explain some important characteristics of materiality principle. Under materiality principle each material item must be disclosed separately in the financial statement to facilitate economic decision making.

Following are some important characteristics of materiality principle

1.   Influence Economic Decision

An element is said to be material, if it could influence the economic decision of the user/stakeholder of financial statement taken on the bases of financial statements.

2.   Determining Factors of Materiality

There are two important factors for defining or determining  the materiality of a financial items i.e. nature & size of the financial item. It is important to note that these factors may be considered individually or collectively to determine the materiality of a financial item. These factors have been explained with example ;

3.   Size & Materiality

Size of the financial item is the most important factor for determining the materiality of financial items. An item is more material with large size, where an item is less material with small size.

It is important to remember that size is a relative to the overall financial statement size. Thus an financial item of $10,000 may be material for small company which has a balance sheet size of $ 100,000, but may be immaterial for a large company which has a balance sheet size of $ 1 billion.

4.   Nature & Materiality

Another important factor for determining the materiality is nature of the financial item. For example a repair expense of 10,000 may not be material, but an entertainment expense of $ 5,000 is material due to nature of expense. in very rare circumstance nature alone determines the materiality of a financial item. 

5.   Materiality Level

Materiality or materiality level cannot be absolutely defined; rather it is defined in context of a specific industry and specific company. There are no hard and fast rules for defining the materiality level.

Materiality level is defined or determined by the management of the company. Some company may define a material item is 2% of asset; other may define it as 3% of profit.

Materiality principle Characteristic List

Some important Characteristics of materiality are listed below

a)   Financial item influences economic decision is material.

b)  Important factor for materiality determination are size & nature of item.

c)   Materiality or materiality level is not an absolute measure.