What is materiality?

Definition

Materiality is the size at which an error, omission, or item is big enough to change a reader's view of the statements. Below that threshold, a miss is still a miss, but it is not expected to change a decision.

In the books, this is a judgment about dollars, not a separate account. It tells the bookkeeper which leftover items need an adjusting journal entry before the statements go out, and which tiny leftovers can wait.

Where it shows up

Balance Sheet: Related to whether an error on the statement is big enough to matter.

P&L: Related to whether an error on the statement is big enough to matter.

Cash flow: Related to whether an error on the statement is big enough to matter.

See also: Adjusting Journal Entry · Audit · Flux Analysis

You will not find a line for this threshold on the Balance Sheet or the Income Statement. It sits behind both statements and decides whether an error on either one is large enough to fix before the package is issued.

A $40 leftover on prepaid expenses rarely changes what an owner, banker, or buyer thinks. A $4,000 unrecorded bean bill on accounts payable usually does.

Cash flow follows the same idea. An error too small to matter on the statements is also too small to matter on the cash report, unless it hides a real cash problem.

How it works

The threshold is not one universal number. A coffee roaster with $80,000 of monthly revenue will treat a different dollar amount as large than a retailer with $8 million.

Bookkeepers still use round tests of thumb, often a small percentage of revenue, assets, or net income. Those tests are a starting point, not a law.

At the end of an accounting period, the bookkeeper lists known leftovers: unrecorded bills, leftover prepaid amounts, small reconciliation discrepancies, and possible write-offs. Each leftover is compared with the threshold.

Items above the threshold get entries. Items well below it may be left until the next period if catching them would not change a reader's view.

Internal controls still require that the leftovers be listed. Skipping the list is not the same as judging an item too small; the judgment comes after the item is known.

Qualitative flags can override a small dollar amount. A miss that hides a related-party payment, a covenant breach, or a pattern of source document gaps can matter even when the dollars look small.

The month-end close is where this judgment usually happens. The trial balance and the general ledger show the numbers; the threshold decides which remaining misses still have to move.

Example

A coffee roaster is closing June. The prepaid-sticker account still has $40 of leftover labels that were used in the last week of the month.

The bookkeeper skips that $40 adjusting journal entry because it will not change anyone's reading of the statements. The leftover is real, and it is also too small to matter.

The same close finds a $4,000 unrecorded bean bill that arrived on June 28. That amount is large enough to matter: inventory or bean expense is understated, and accounts payable is understated by $4,000.

The bookkeeper records the $4,000 bill before the statements go out. The $40 sticker leftover waits until July.

A reader of the June Income Statement and Balance Sheet now sees the bean cost that belongs in June. They do not see a $40 sticker timing difference, and they would not have changed a decision if they had.

Common mix-ups

This threshold versus sloppy books. A size cutoff is not permission to ignore the chart of accounts or to skip listing leftovers; every known item still gets reviewed, and only the tiny ones can wait.

This threshold versus an audit. An auditor also uses a size cutoff when planning an examination, but that is a later, independent judgment, not the bookkeeper's decision about what to correct on the statements themselves.

This threshold versus flux analysis. Flux analysis explains why an account moved compared with the prior period; the cutoff on this page is about whether a miss is big enough to matter, not about why a line changed.

Related terms

• Adjusting Journal Entry: An entry made at period end to record accruals, deferrals, and corrections.
• Audit: An independent examination giving an opinion on whether statements are fairly stated.
• Generally Accepted Accounting Principles: The common US rules for how financial statements are prepared.
• Flux Analysis: Explaining why each account moved compared with the prior period.
• Reconciliation Discrepancy: An unexplained difference left after a reconciliation is attempted.
• Write-Off: Removing a balance from the books when it will not be collected or paid.
• Internal Controls: The procedures that keep the books accurate and assets protected.
• Capitalization Policy: The written dollar threshold and rules for recording a purchase as an asset instead of an expense.