Materiality in financial reporting

Materiality is a working threshold that a company agrees with its auditor before preparing its financial statements and then applies to every disclosure decision: which item gets its own line and note, and which is folded into an aggregate "other" line. A misstatement or omission is considered material if it could change the economic decision of a user of the financial statements; everything else is treated as noise and needs no separate disclosure.

How the threshold translates into the level of detail in the statements

The threshold is calculated from a benchmark that reflects the scale of the business: the balance-sheet total, revenue, profit before tax or equity. The benchmark is chosen to suit the nature of the business, so a bank and a retailer with comparable turnover end up with different thresholds and different levels of detail in their notes.

The overall threshold is then allocated across accounting areas: each line item receives its own share of the limit, so that the tolerable misstatements accumulated across items do not exceed the whole. This explains why inventories and intangible assets are examined in different depth — it depends not on how important the item is to the reader but on its weight in the chosen benchmark. Qualitative materiality operates alongside this: related-party transactions, management remuneration and covenant breaches are disclosed regardless of size, because they are significant in their own right. The approach applied and the conclusions on the misstatements identified are set out in the auditor's report.

Example: the figure the threshold is calculated from

The scale of the benchmark can be read from the issuer's total assets line:

52 307 000 000 000

For statements of this kind, the threshold is calculated from this figure. A transaction that would warrant a separate note at an average company will stay below the threshold at an issuer like this one and end up in an aggregated line — not because it was hidden, but because it is not capable of shifting the overall picture.

What materiality is not

It is often confused with the rounding of the units in which amounts are presented: statements may be expressed in large units, but the materiality threshold is set separately and has nothing to do with how the tables are formatted. A second misconception is applying the group's threshold to an individual segment or subsidiary: materiality is calculated for the financial statements as a whole, so a fact that is decisive for one business line gets lost in the consolidated financial statements. Finally, immateriality does not mean that an event did not occur: an impairment or a disputed charge below the threshold did take place in the reporting period; it simply did not get a line of its own.