Materiality is the threshold above which missing or incorrect information in financial statements is considered to have an impact on the decision making of users. Materiality is sometimes construed in terms of net impact on reported profits, or the percentage or dollar change in a specific line item in the financial statements. Examples of materiality are as follows:
- A company reports a profit of exactly $10,000, which is the point at which earnings per share exactly meet analyst expectations. Any reduction in profit below this point would have triggered a sell off of company shares, and so would be considered material.
- A company reports a current ratio of exactly 2:1, which is the amount needed to meet its loan covenants. Any current asset or current liability amounts resulting in a ratio of less than 2:1 would be considered material, since the loan could then be called by the lender.
Based on the preceding examples, it should be clear that sometimes even quite a small change in financial information can be considered material.