Materiality

[lovely]

Please answer the following questions;

One of the constraints of conceptual framework for financial reporting, “Information is material if its omission or misstatement could influence the economic decisions of the users taken on the basis of the financial statements.”

1. Explain the statement in detail with examples.
2. In the context of the above statement, would you capitalize the following items in the accounts of a company? Discuss each item in detail.
a. A box file
b. A computer
c. A small plastic display stand

[Ubaid15]

I can try and explain materiality in simple terms. One of the primary users of the financial statements are the shareholders. "Information" in the financial statements can be anything, disclosures, line items in the Statement of financial position and so on.

What is meant by materiality is, keeping the overall position of the entity in context, information may be worth mentioning or not. For example, let's assume there are two entities, "A" which is a multinational which has transactions of Rs. 10,000,000 in a year and "B" which has transactions of say Rs.20,000 in a year.

Both these entities prepare financial statements. Now let's assume both of these entities buy stationery worth Rs.500. Considering the overall position of "A" Rs.500 spent on stationery might not be 'material', that is, its reporting would no doubt increase accuracy of the financial reporting BUT would not be worth the extra time and cost associated with going through the trouble of reporting a small transaction of worth Rs.500.

However, for entity "B" which has transactions totaling Rs.20,000 in a month, Rs.500 is material since the Rs.500 makes up (500/20,000)*100 = 2.5 % of its yearly transactions. If you omit or misstate this amount, it will overstate or understate your profit - since expenses reduce the profit.

For "A" the Rs. 500 transaction is (500/10,000,000)* 100 = 0.005 % percent of its monthly transactions. So for that entity, this information is probably immaterial.

Materiality for different entities is different, depending on what they think is important enough to be reported or irrelevant enough to not be reported without misstating the financial statements.

[Dard]

Lovely your first point was answered very well by ubaid15
Regarding your second point, as mentioned by ubaid15, materiality level depends on an entity. An ommision of a computer from the financial statements of small computer dealer might be material. Whereas the same ommision for a large textile company will not be material. A plastic display stand and box file may not be material in any entity because of their very low values compared to total assets

[Schuaeb]

<blockquote id="quote"><font size="1" face="Verdana, Arial, Helvetica, san" id="quote">quote<hr height="1" noshade id="quote"><i>Originally posted by lovely</i>
<br />Please answer the following questions;

One of the constraints of conceptual framework for financial reporting, “Information is material if its omission or misstatement could influence the economic decisions of the users taken on the basis of the financial statements.”

1. Explain the statement in detail with examples.
2. In the context of the above statement, would you capitalize the following items in the accounts of a company? Discuss each item in detail.
a. A box file
b. A computer
c. A small plastic display stand

<hr height="1" noshade id="quote"></font id="quote"></blockquote id="quote">

Materiality at first place has nothing to do with the capitalization or expensing of a transaction. Any expenditure that meets the capitalization criteria i.e. its economic benefits will be derived for more than one accounting period shall be capitalized.

Coming to the point you seem to have asked; any immaterial expenditure incurred that meets the capitalization criteria may be expensed for simplicity depending upon the accounting policy. Many organizations have the policy to expense capital expenditure below a specific threshold.

Hopefully, I have explained what I intended to.

Regards
Shoaib