Accounting Materiality Case
To: The Framework Company
After the release of the SFAC No. 8, your definition of materiality has been brought into question. In the past, your rule for determining materiality was based solely on quantitative data, where an event was only material if its impact was more than a given percentage of the income statement amounts. Using a quantitative measure is effective because it keeps the process objective; however there are also times when the quantitative difference doesn’t adequately demonstrate the true effect of an action. For this reason, “materiality is an entity-specific aspect of relevance based on the nature [quality] or magnitude [quantity] or both items,” as stated in Q:11 of the SFAC No. 8. For The Framework Company each of the following closing entries must be judged on a case-by-case level on the parameters of whether it could influence decisions that our users make.
1) In this entry, the company is paying a fine of a foreign subsidiary. The amount is less than 3% of net income, making it quantitatively immaterial. The description of the case lists that after the fine is paid, business will go back to normal with only slight changes. However, this is qualitatively material because it shows that the company did something unlawful which makes users question the company’s integrity and ethical standards.
2) This entry shows an investment in an expansion of the company. The impact on the company amounts to only 4.3% of its total assets (it was predetermined that the bar for materiality is 5%) so it is not quantitatively material. However, in terms of this action affecting a user’s decision about the company, this entry is definitely material. It represents an expansion of the company which users can either see as promising for future growth or frightening because it’s a risky investment.
3) Generally a loss, no matter the size isn’t seen as material due to the fact that it tends to be a one-time thing, compared to an expense that
After the release of the SFAC No. 8, your definition of materiality has been brought into question. In the past, your rule for determining materiality was based solely on quantitative data, where an event was only material if its impact was more than a given percentage of the income statement amounts. Using a quantitative measure is effective because it keeps the process objective; however there are also times when the quantitative difference doesn’t adequately demonstrate the true effect of an action. For this reason, “materiality is an entity-specific aspect of relevance based on the nature [quality] or magnitude [quantity] or both items,” as stated in Q:11 of the SFAC No. 8. For The Framework Company each of the following closing entries must be judged on a case-by-case level on the parameters of whether it could influence decisions that our users make.
1) In this entry, the company is paying a fine of a foreign subsidiary. The amount is less than 3% of net income, making it quantitatively immaterial. The description of the case lists that after the fine is paid, business will go back to normal with only slight changes. However, this is qualitatively material because it shows that the company did something unlawful which makes users question the company’s integrity and ethical standards.
2) This entry shows an investment in an expansion of the company. The impact on the company amounts to only 4.3% of its total assets (it was predetermined that the bar for materiality is 5%) so it is not quantitatively material. However, in terms of this action affecting a user’s decision about the company, this entry is definitely material. It represents an expansion of the company which users can either see as promising for future growth or frightening because it’s a risky investment.
3) Generally a loss, no matter the size isn’t seen as material due to the fact that it tends to be a one-time thing, compared to an expense that