Understanding The Materiality Concept In Accounts
The materiality concept is universally recognised accounting convection that ensures firms disclose everything relevant to the intended audience. It entails all the information in the financial statements that can affect the decision making of its users. Materiality helps auditors and accountants in deciding separations of data and figures when reporting. It also helps in understanding the amount in which omissions and errors should be avoided. Careful judgment is required when deciding whether the information is material or not. The materiality of the information can be decided due to the size of the amount or the event in which the information is submitted. Materiality judgment can be more uncertain hence less objective. It depends on the people on who the decision rests upon since it might be subjective. In simple terms, materiality refers to the outcomes of a judgment made based on the nature of the information given influenced by the magnitude of misstatement or omitted accounting information. To bring you closer home, here are your guidelines;
The Purpose and Audience – Materiality in the annual report
The information submitted in this report should be precise since it influences many decisions on hold. In case there is any voting required, all the informing regarding the candidates should also be fully submitted. The shareholders should be able to come up with a clear picture of the firm’s status. This information helps the investors in coming up with informed decisions hence the materiality concept is required to be in full disclosure. The report should be:
- Fully transparent regarding the recent performances of the firm
- The competitive nature of the firm
Materiality for lenders and bond rating agencies
Lenders and bond rating agencies also require material information since they use it in deciding the creditworthiness of a firm. In this, the audience tries to understand the following;
- What is the firm’s level of leverage?
- Can the firm be able to pay off the earlier debt and service another debt?
- The firm’s overall earnings in its line of business?
The is audience must come up with answers regarding the above questions hence needs full disclosure on the company’s creditors, liabilities, and investments. The audience also needs to understand the firm’s plans regarding finances, strategies and business models.
Materiality for acquisitions and potential mergers
Here all the engaged audiences require knowing its potential business partner in full details accurately. The following should be their primary concerns;
- Cost structure- a method of determining how much it will cost a firm in producing a product and the average profit generated from it.
- Business model- refers to the products that a firm depends on in generating revenue and its desired customer.
- Capital and financial structures- this shows the level of leverage regarding the risks that the firm’s investors have taken to make the business grow.
The potential partners require knowing all these information before merging with a firm. All the involved parties should understand the difficulties of their business venture before the partnership is forged
Subjectivity in Judging Materiality
Materiality judgment can be more uncertain and less objective depending on the specific information submitted. Therefore, the judgment might be influenced by specific details whether misstated or omitted thereby making materiality a subjective element. It further makes the decision uncertain since different people understand it differently. Therefore, materiality judgment can differ among the following;
- Senior managers
- The board of directors
The difference judgments can be further cultivated by the individual’s motivations, interests and end games.
Materiality abuse can have serious legal consequences although there is a margin for error. Though in a court of law, several rules are used in specific cases. Some of these rules are;
On the balance sheet, an entry of more than 0.5% of the total assets can be viewed suspiciously
On the sales revenue, a 0.5% margin can be viewed suspiciously
5% errors on the income statement or more before-tax profit can be questionable
Other factors must also be considered when judging materiality, thus the reason as to why the regulators do not set a specific size of materiality abuse. They also consider the following factors;
The intent behind the error- an abuse can only be certified if either the court of law or the auditors can prove the intent of such a mistake. Thus determine whether the error was legit or fishy
The likely effect on the user- if the mistake established has any harmful aftermath effects, then it might be proved as a fraud
In general, materiality is required in making the firms’ goals and decisions. Mistakes made when compiling the financial statements might affect the firm’s plans adversely. It is advisable to hire accounting services singapore firms and work with them in making the best decisions for your company.