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Understanding materiality in accounting

When it comes to finances, mistakes are rarely forgiven. This is why accounting is such a high-stakes profession. There are several terms that all accountants and aspiring accountants must be aware of – terms that all small business owners would benefit being aware of. Materiality is one of these terms.

What is materiality?

In accountancy, you would define materiality as the relative size of an amount, with large amounts being material and small amounts being immaterial. This is important when choosing which expenses to include on a financial statement.

Whether or not an amount is material or immaterial will depend on the situation and the size of the business. For example, £10,000 might be immaterial for a business with a net income of over £1 million, whereas it would be material for a small business with a net income of only £30,000.

Materiality assessment 

Generally speaking, if the information that’s being offered on the financial statement would have an impact on how those reading the statement (such as investors) act, the item is material and cannot be omitted. If the item has no relevance on the action the party takes or was going to take then it is immaterial.

Of course, there is a lot of wiggle room in the definition and assessment here, as is often the case in financial law. Generally speaking, however, it’s always relative to the size of the business and individual circumstances. For example, if a large business plans to cease or scale back operations in a segment that was a large source of revenue for them, it should be disclosed in financial statements.

Essentially, materiality allows a business to ignore certain accounting standards to make their financial lives a little less complicated. Of course, there have been countless situations where the difference between materiality and immateriality has been debated, as they have never been exactly defined. This is a subject that remains divisive in accounting circles.

Materiality is also often linked to other accounting principles such as:

Relevance

If material information influences the decisions of the user then it’s relevant to their needs and must be disclosed.

Reliability

If the omission of information on the statement makes that statement less reliable then it is a material amount.

Completeness 

To present a true reflection of the business’s finances, all material amounts must be complete.

Materiality examples

  • If a business stumbles upon an accounting error that would require already filed financial statements to be redacted and altered, it is only worth doing so if the amount missed in error could be classified as material.

  • If an accountant is waiting to receive several invoices before closing the books and decides to estimate those invoices rather than wait for them, that final figure is likely to be at least a little inaccurate. If the variance between the genuine amount and the predicted amount is small enough then it can be classified as immaterial.

  • If a business purchases an asset (such as a computer) that falls below the corporate capitalisation limit, it could be deemed immaterial.

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