Glossary term
Materiality
Subject: Governance, Internal Control and Audit
Materiality is the threshold of size or nature above which a mistake or omission would change what readers of a report, such as investors, lenders or regulators, decide.
Explanation
Not every mistake changes anyone's view. A rounding difference in a large set of accounts will not change anyone's view of the company, but a hidden loss will. Materiality is the test used to separate the two. It depends on both size and nature: a small payment to a director that breaks the law, or an error that turns a profit into a loss, can be material even if the amount is low. Auditors set an overall figure when planning, commonly tied to a percentage of a benchmark such as profit or revenue, and a lower working level for testing individual items. Management applies the same idea when deciding what to disclose. In sustainability reporting the concept is widened: financial materiality asks what affects the company's value, and double materiality adds the company's effects on people and the environment. It sets what gets investigated, corrected and reported, and what is left as noise.
Example
For a retailer with 500 million in sales, the auditor sets planning materiality at 1% of revenue, which is 5 million, and a testing threshold of 3 million. She finds an overstated inventory balance of 4 million and reports it as above testing level. A 20,000 misclassification between two expense lines is left uncorrected and noted as trivial.