The materiality concept or principle is an accounting rule that dictates any transactions or items that significantly impact the financial statements should be accounted for using GAAP exclusively. In other words, if a transaction or event happened during the year that would affect how an investor would view the company, it must be accounted for using GAAP on the financial statements.
Transactions or events that are deemed to be not material can be ignored because they won’t affect how investors and creditors view the financial statements to make their decisions. Non-material transactions are usually small or have very little impact on the overall company bottom line.
It might be helpful to look at a few examples.
Assume Bill’s Dry Cleaning service has annual revenues of $40,000. He decides to upgrade his equipment during the year and replaces one of his dryers for $15,000. This is a significant event in the company’s year because investors and creditors will definitely want to know about a purchase that equals over 30 percent of annual revenues. This asset should be capitalized and placed on the balance sheet.
After a year of having the new dryer, Bill had a belt go out on it. It cost him $250 to have the machine repaired. This is not a significant event. It doesn’t really matter how Bill records this transaction. He can expense it in the repairs and maintenance account or he can capitalize it and add it to the asset. It is not material. Either way investors or creditors’ opinions of the financial statements and health of the company will not change no matter how he records this transaction.
In short, the materiality concept is concerned about events that are significant in nature and affect how end users view the financial statements.
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