Materiality Concept

The concept of materiality places a constraint on what should be recorded and reported. It emphasizes that Generally Accepted Accounting Principles need not be applied to immaterial facts. Kohler defines materiality as, 'The characteristic attaching to a statement, fact, or item whereby its disclosure or the method of giving it expression would be likely to influence the judgment of a reasonable person.' This concept assumes significant importance in reporting financial statements. In the area of reporting, information is said to be material if it affects or is likely to affect the decision made by a user of the financial statements. For example, an error of Rs.1,000 in finished goods inventory whose total is valued at a few crores of rupees is definitely meager to warrant special attention (the error is immaterial), while the same needs attention in case the total stock amounts to a few thousands. Thus, the concept of materiality is relative in the sense that what is material or immaterial depends on the circumstances, nature of the item, the nature of the business and various other factors.

A few established and accepted general rules in support of this concept are:

    Prior year adjustments should be preferably reported distinctly and below the line. A common instance is the payment of income tax dues wherein the sum ultimately remitted to the revenue after assessment significantly varies from the provision made earlier. Such differences ought to be debited/credited, as the case may be, and reported below the line as a part of appropriation.

    The magnitude of net profit and the size of the group to which the item belongs needs to be necessarily considered in ascertaining the materiality of the said item. Similarly for the constituents of the balance sheet the total assets and liabilities as well as the group/sub-group concerned ought to be examined.

    Significant and substantial changes occasioned by the changes effected in the accounting policies along with the accompanying impact on the profit/loss of the enterprise for the relevant accounting year have to be reported separately on the basis of doctrine of materiality. Financial transparency requires a change to be given effect only when it is required by law, compliance with well established standards and if such changes leads to a better presentation of financial statements.