What does (materiality) mean in terms of (financial statements)?

It is really surprising how in a matter whose nature is inherently quantitative and whose rigor is based on accuracy, an indefinite concept such as “materiality” has as much prominence. The Auditors use this term in a loosely dialectical manner, which contributes to the abuse and over use of the word in slang, rather than for its intended meaning.

But what is materiality?

International accounting standards refer to accounting materiality through the establishment of the principle of relative importance, in which it is determined: “the failure to strictly apply some of the accounting principles and criteria will be admitted when the relative importance, in quantitative or qualitative terms of the variation that such a fact produces, is scarcely significant and, consequently, does not alter the expression of the faithful image”.

In addition to establishing the principle that governs materiality, the term relative importance allows the exclusion of certain items, data, and facts from the financial statements that are deemed not materially relevant, and therefore do not have to be disclosed to potential users.

Materiality, in accounting terms, assumes the significance that certain facts or data have in the decision making of a reasonable user, and how their inclusion or omission within the financial statements will have consequences in the evaluation of past, present and future events.

Therefore, we may say that the accounting materiality depends on the valuation criterion of the preparer of the financial statements, regarding the information and facts that they must contain, as well as the items that may be aggregated, added, or the headings and subtotals that they must contain.

The users of this financial information may have different expectations about financial statements, but the materiality principle does not require that the information disclosed necessarily meet the particular expectations of these users. The financial information need only provide useful information for current and potential investments and creditors, as well as for other users in the rational decision making of investment, credit and similar matters. Additionally, relative importance will be assessed on the terms of a reasonable user. If the financial statements contain material misstatements, they will comply with neither the International Accounting Standards (IAS), nor with internal accounting regulation.

When is it understood that a fact is materially relevant, and that by the application of the principle of relative importance, its exclusion is not permitted?

In our accounting and auditing standards, we have chosen to follow two elements in order to determine the materiality of the facts: the magnitude and the nature of the omission or inaccuracy, based on the particular circumstances in which it occurred. Either by considering one of these two elements individually or through a combination of both.

The Accounting and Auditing Institute (AAI) through its resolutions and consultations, continues to define this term. In this regard, we bring to mind the technical rules on materiality and on errors and irregularities, dated June 14th, 1999 and June 15th, 2000.

The technical rule of relative importance defines materiality as the extent or nature of an error (including an omission) in financial information that, either individually or as a whole, and in light of the circumstances surrounding it, makes it likely that the judgment of a reasonable person, who relies on the information, would have been influenced or affected by the error or omission.

Errors, Irregularities and Materiality

Similarly, the technical auditing rule on errors and irregularities, such as acts or omissions not intentionally committed by one or more individuals such as: managers, directors, employees or third parties unrelated to it, that alter the information contained in the annual accounts, such as:

• Arithmetic or transcription errors and accounting data; inadvertent or incorrect interpretation of the facts; incorrect application of accounting principles and standards.
• Irregularities that may involve manipulation, falsification or alteration of records or documents; misappropriation and irregular use of assets; deletion or omission of the effects of transactions on records or documents; registration of fictitious transactions; improper and intentional application of accounting principles and standards. From this point of view, we will understand that there is an irregularity or material error in the financial statements when, from a qualitative point of view, due to the nature of the incidents, the user of the financial statements is deprived of correct, necessary and sufficient information. Likewise, from a quantitative point of view, it will be relevant when the monetary magnitude of the incidences found, related to the size of the company, significantly alters the net worth or financial situation projected for the company. If the variation produced by this error, irregularity, in the lack of information, is insignificant, and does not alter the faithful image of the patrimony, it will be covered by the materiality allowed under the principle of relative importance.

http://www.icac.meh.es/Documentos/PUBLICACIONES/89.pdf