Materiality
The threshold above which financial information could influence user decisions if misstated, guiding audit scope and determining when adjustments are necessary.
Materiality
The threshold or magnitude above which missing or incorrect financial information could influence the economic decisions of financial statement users, guiding auditors in determining audit scope and evaluating misstatements.
For instance, a $50,000 inventory error might be immaterial for a large multinational corporation with $10 billion in assets but highly material for a small business with $500,000 in total assets, influencing how extensively auditors would investigate this area and whether correction would be required.
Materiality involves both quantitative factors (numeric thresholds often based on percentages of metrics like total assets, revenue, or pretax income) and qualitative considerations (such as whether misstatements affect compliance with loan covenants, mask changes in earnings trends, or relate to segments important to the entity’s future). Auditors establish overall materiality for planning purposes, set performance materiality (lower thresholds for testing) to provide margin for undetected errors, and evaluate both individual and aggregate misstatements. The concept acknowledges that absolute precision in financial reporting is neither necessary nor economically feasible, focusing audit efforts on matters significant enough to impact user decisions.