Materiality concept in accounting guide the recognition of transactions. Materiality concept ignores the other concept if the effect is not considered material.
What is materiality concept in accounting?
Materiality concept in accounting is an accounting convention that guides the recognition of transaction.It means transaction of little importance should not be recorded.
Further transaction may be recorded but relevance and significance should be kept in mind.
Materiality concept permits other concepts to be ignored if the effect is not considered material.This principle is exception to full disclosure principle.
According to this concept all items having significant economic effect on business enterprise should be disclosed in financial statements. And any insignificant item which will only increase workload of an accountant but not be relevant to user should not be disclosed in financial statement.
The term materiality is a subjective term. It is on the basis of judgement,common sense and discretion of accountant that which item is material and which is not.
For instance stationary purchase in business is not fully used in accounting year still shown as expenses of that year because of materiality concept.
Similarly, depreciation on books and calculator is taken as 100% in the year of purchase though use by entity is more than a year. This is because amount of books or calculator is very small to be shown in balance sheet in spite of it is asset of company.
The materiality concept is not only depends on amount of items but also on size, nature of business.
The omission of any information should not impair decision-making of various user.
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.
Example of materiality concept in accounting
- An entity having annual turnover of Rs.25,00,000 and cash lost Rs. 500 is not material . Becasue ,this amount is immaterial and may not be regarded as a material misstatement that would impact the financial information on the balance sheet.
- Suppose in the above example the bank balance is misstated by Rs. 1,50,000 than this must be disclosed in financial statements as it is material and will affects the financial statement.
How materiality is relevant in accounting?
In accounting the concept of materiality is relevant in following situaton:
- For considering whether whether item should be disclosed in financial statement
- And for making decision about item as an expenses or an investments.
The main objective of this concept is to ensure that financial statements are accurate and reliable.
Further, accountant should consider the qualitative and quantitative factors in determining the materiality of an item.
Further, qualitative factors means cash flows , total assets, revenue profit , net income etc. The 1% threshold is applied to determine quantitative materiality.
Qualitative factors means related party transactions , unusual transaction, and broader economic uncertainty etc.
Conclusion:
Materiality is principle states that material item must be properly reported in financial statement. An it allow the company to violate another accounting principle if item in question is immaterial.
Materiality means item is consider material if omitting or misstating could influence decision of user of financial statements. Item that have very little or no impact on users decisions are termed as immaterial.
