Question

When a corporation wishes to issue certain securities; it must provide sufficient information for unsophisticated investors to evaluate the financial risk involved. Specifically, the law imposes liability for making a false statement or omission that is “material.” Answer the following questions.

a) Define materiality. Be specific.

b) Provide two examples that would be considered material.

c) Provide two examples that would not be considered material.

Answer 1

Requirement a

Materiality is a measure of significance or importance of an item. In financial statement’s terms, an item is said to be material if the incorrect disclosure or non-disclosure of the item or a transaction can influence the decision made by the user of financial statement. Materiality is a relative term, that is materiality changes from company to company. Material items should be disclosed in the financial statement.

Requirement b

Example one:- When a corporation decides to expense of a huge investment in asset, instead of capitalising it, is an material item. The same needs to disclosed in financial statement.

Example two:- Writing off of bad debt of a huge client is an material item if the size of bad debt is more than 5% of net income.

Requirement c

Example one:- On the same note as above, if the huge corporation purchased a small printer, it can expense off this investment rather than capitalizing as the cost of printer is not material. However, if on a cumulative basis, that is if many number of printers are purchased during the year, then the transaction will become material.

Example two:- Again on the same note as above, if the corporation is writing off debt of a small debtor for $500, then that is not a material amount and does not require additional disclosure.