Materiality

The other constraint that all statements must adhere to without exception is materiality. It is similar, yet different, to benefits > constraint. Financial information is classified as material if upon omission the user's decision could be affected. Materiality depends on the relevant situation and the nature or magnitude of the item. Materiality says that the dollar amount of the information must be material, meaning that the information must be large enough that it will make a difference in decision making. For example, if you purchase pens on December 1st, you will not use them up until the following year. As previously learned, we have an adjusting entry on December 31 of the year these supplies are used up. However, didn't we use the pens to make revenue the year we purchased them? Based on the matching principle we should capitalize these pens over their useful life, right? This is where materiality comes in. It is absolutely not worth capitalizing over the life of the pen since we'd have to take an expense in Year 1 of say, $0.50, and in Year 2, of $3.50. Would that $0.50 make a difference in your decision making? I don't think so. Although it may fit the costs constraint, it simply is not worth making the decision to go to this trouble. Although the responsibility of management is to apply GAAP appropriately, auditors serve as independent intermediaries to ensure that management has appropriately applied GAAP in preparing the company's financial statements. One method used in this determination is materiality. An auditor uses professional judgment to determine an amount as material if omitted or misstated, then the auditor would propose and audit adjusting journal entries to ensure that the financial statements are free of material misstatement.