How to Determine Materiality When Auditing an Account

There is no definitive measure of materiality.
There is no definitive measure of materiality. (Image: John Foxx/Stockbyte/Getty Images)

Materiality is the relative importance of an item or event. It is the judgment of the accountant to determine whether a misstatement, omission or error in the account affects the financial information of the company. The materiality principle allows insignificant things and accounting principles to be ignored when there is no effect on the users of financial information. For example, recording the purchase of office supplies to the building expense account will not change the total expenses and is therefore immaterial.

Determine whether or not the error affects the financial reports of the company. Appropriating funds to the wrong accounts oftentimes will not affect the total net profit or balance sheet and is immaterial. An immaterial error can be ignored and no correction is necessary.

Calculate the amount of the error or misstatement. Determine what percentage of change is needed to consider the error material. Slight changes creating a discrepancy of less than 5% are generally not considered to be material. The exact percentage threshold is determined by company management and the accountant.

Consider the size of the company you are auditing when determining materiality. An error of several thousand dollars may have no effect on a corporation with a million dollars in revenue, but will be material to a company with $100,000 in revenue.

Tips & Warnings

  • Materiality is based on the sole judgment and expertise of the accountant.

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