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The convention of materiality emphasizes that financial statements should include only material facts—those that are important and relevant to users of accounting information.
The materiality of an item is determined by its nature and the amount involved. A material fact is information that can influence the decisions of its users.
For instance, consider a business owner dealing in furniture and household goods. This owner invests a significant portion of capital in purchasing Furniture and household goods. These purchases are substantial and should be meticulously recorded in the financial accounts.
Conversely, small office supplies like Printing and Stationery item and other miscellaneous office item require a minor fraction of the capital and are not as critical to record in detail. These minor items are considered insignificant and should be grouped together under a separate accounting category.
In summary, items of considerable importance and impact on the financial records are termed material facts or significant items. Conversely, items of lesser importance are deemed immaterial facts or insignificant items. The convention of materiality stipulates that significant items should be recorded in their specific accounts, while immaterial transactions should be aggregated under a different accounting category.
The significance of the Convention of Materiality includes:
Focusing on material facts helps to minimize the potential for errors.
Users can make more informed decisions based on pertinent information.
Less effort is required to record and maintain details of insignificant items.
Read the next article to learn more about the next Convention of Conservatism.