Materiality

Materiality is a strange accountancy calculation for many different reasons. The first reason is that it is often not calculated to an exact figure. By that I mean when you calculate materiality you will most likely round that figure to a nice whole number. This goes against the grain as 99.99% of the time our figures must be as accurate as humanly possible. Although even if it was calculated to an exact figure there is still the possibility of that figure being unrealistic or just wrong.

Another varying element with materiality is who decides what is material for this organisation? Just last week I was questioning KPMG Auditors over there decision to set materiality at 1.5% (of total expenditure) for West Devon Borough Council. During the conversation I discovered they have a maximum and a minimum percentage that they will apply for different organisations. The higher risk you are the lower percentage materiality they will use and vice versa. Interestingly they calculated materiality on expenditure instead of income which is different to the commercial world where you would normally calculate it on turnover.

This is all nice to know but how does this help charities or even small businesses? First we need to understand the concept. Materiality is really a tool to help prevent charities and businesses getting weighed down by insignificant errors in reporting on accounts. If there was not a similar mechanism in place entities would be endlessly making minor adjustments to accounts. Having a measure as to what is classified as a serious error helps auditors and accountants make reasonable decisions on the accuracy of the accounts.

Another side of materiality is that it acts as a safety net. By this I mean materiality is there to insure there is a limit on how big a mistake can go unadjusted. Remember lots of little mistakes or errors can add up to being material so it’s never worth ignoring items that are not considered material. Often auditors will raise adjustments that could be made but are not of a material nature and can be adjusted moving forwards. It is important to work well with auditors at the same time as not becoming too familiar.

As a charity it is important to make sure your materiality percentage makes sense but also gives you enough room to move freely. Setting it at anything below 0.5% is probably too low but above 4% is far too high. Other things you need to consider are what will you calculate materiality on? As a charity calculating it on turnover(income) may not be the best way as regularly charities spend more than they receive. You could of course have two separate materiality levels one for income and one for expenditure.

One last thing to say and that is once the level of materiality has been set for the year you must abide by that level. You cannot suddenly decide to increase your materiality level because of what you find.