Definition and Explanation
The materiality principle of accounting guides about recognition of a transaction. It means that transaction which is of insignificance importance should not be recorded. A transaction may be recorded keeping in view its relevance and significant importance e.g. a newly purchased pencil is an asset of the business. Whenever the pencil is used a part of asset is consumed.
Although pencil is still available at the end of the year but its original cost is so insignificant that it would be a waste of time to include it in closing stock, therefore it is written as the expense for the period in which it was purchased. Similarly recorded figures are used without affecting the accuracy of accounting data.
Therefore; Materiality principle of accounting allows the accountants to ignore other accounting principles with respect to items that are not material. There are no hard and fast rules to judge the materiality about an item. However, factors like size of business can be used as the basis for deciding about the materiality of any transaction.
While matching concept and accrual concept requires an accountant to accurately calculate the exact cost to be charged to the income statement for any particular period, the materiality principle of accounting states that this should be done only to the extent that it is material. Unnecessary details should be avoided as the cost of going into such details is often greater than the benefit of the exercise.
For example, if a box file is bought for $5, it is likely that it will last for five years or more. Yet it would be tedious, time-consuming, expensive and generally inconvenient to treat a file cover costing $5 as a fixed asset and depreciate it over five years using the straight-line method. It would be far easier to call the entire cost of $5 as an expense for the year in which the box file is bought. It would not materially misstate the profit for that year (or remaining four years).
It is difficult to set a limit as to what is material, as this would differ from organization to organization. For large multinational companies, an expense of $200 may be too small to capitalize while a retail shop might consider assets costing $200 large enough to be treated as an asset rather than an expense. Most companies have internal rules about such limits. Once such rules or limits are set, they should be consistently applied.