What do we mean by Materiality Concept

May 31st, 2006 Comments off
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Do you know the importance of having consistently practise the materiality concept or principle? Just imagine that the financial statements namely the Income statement and balance sheet are not based on the materiality concept or principles, every single cent of items omitted by the preparer will need to be reinstated or adjusted into the books of accounts.
Below summarizes the materiality concept or principles in more details:-

MATERIALITY CONCEPT

  • Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements
  • Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor

ILLUSTRATION NO.1

Company A bought 6 months supplies of stationery costing $600.

Question: Should the company spread the cost of this stationery for 6 months by expensing off $100 per month to the Income Statement ?

Answer : Based on this concept, as the amount is so small or immaterial, it can be expensed off in the current month instead of tediously expensing them for the next 6 months

ILLUSTRATION NO.2

Company A purchases a $200 hand phone and expenses it immediately instead of recording it as an asset and depreciating it over its useful life.

Question: Is this practice acceptable?

Answer: This practice is acceptable of the materiality concept as the value of item purchased is to small to justified booking it in as fixed asset.

ILLUSTRATION NO.3

Company A is a very large corporation. The company prepares the financial statement by rounding down to the nearest thousand.

Question: Is this permissible?

Answer: Based on the materiality concept, this is permissible.

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