--- title: "Auditing Concepts: Close-Up On Materiality" description: Machen McChesney provides companies with information on why materiality is a vital accounting concept and is one of the gray areas in financial reporting. image: https://info.machen.cpa/hubfs/The%20word%20Audit%20-1269552004-1.jpeg --- [Family of Services](http://machenmcchesney.com/about-us/family-of-companies/)  |  [CPA & Business Advisory](http://machenmcchesney.com)  |  [Payroll, HR & Benefits](http://focuspaysolutions.com/)  |  [Wealth Management](http://machenmcchesney.com/services/financial-planning-and-wealth-mangement-services/) Auburn-Opelika (334) 887-7022 | Montgomery (334) 244-8900 [![mm-re-cobrand-fd-blues](https://info.machen.cpa/hs-fs/hubfs/mm-re-cobrand-fd-blues.png?width=279&height=100&name=mm-re-cobrand-fd-blues.png)](http://machenmcchesney.com) Search this site on Google Search Google Search this site on Google Search Google - [Client Portal](https://machenmcchesney.sharefile.com/Authentication/Login) - 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Waller, CPA](https://info.machen.cpa/blog/author/aaron-k-waller-cpa) on Jan 17, 2024, 8:32:35 AM - [Tweet](https://twitter.com/share) ![The word Audit -1269552004-1](https://info.machen.cpa/hs-fs/hubfs/The%20word%20Audit%20-1269552004-1.jpeg?width=1024&height=299&name=The%20word%20Audit%20-1269552004-1.jpeg)As audit season begins for calendar-year entities, it’s important to review issues that may arise during fieldwork. One common issue is materiality. This concept is used to determine what’s important enough to be included in — and what can be omitted from — a financial statement. Here’s how materiality is determined and used during an external financial statement audit. **What is materiality?**  Under U.S. auditing standards and Generally Accepted Accounting Principles (GAAP), “The omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is *probable* \[emphasis added\] that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.” This aligns with the definition of materiality used by the U.S. judicial system. However, it differs somewhat from the definition set by the International Accounting Standards Board. Under International Financial Reporting Standards (IFRS), misstatements and omissions are considered material if they, individually or in the aggregate, could “reasonably be expected to influence the economic decisions of users made on the basis of the financial statements.” **How do auditors determine the materiality threshold?** Auditors rely on their professional judgment to determine what’s material for each company, based on such factors as: - Size, - Industry, - Internal controls and - Financial performance. During fieldwork, auditors may ask about line items on the financial statements that have changed materially from the prior year. A materiality rule of thumb for small businesses might be to inquire about items that change by more than, say, 10% or $10,000. For example, if shipping or direct labor costs increased by 30% in 2023, it may raise a red flag, especially if it didn’t correlate with an increase in revenue. Businesses should be ready to explain why costs went up and provide supporting documents (such as invoices or payroll records) for auditors to review. Establishing what’s material is less clear when CPAs attest to subject matters that can’t be measured — such as sustainability programs, employee education initiatives, or fair labor practices. As nonfinancial matters are taking on increasing importance, it’s critical to understand what information will most significantly impact stakeholders’ decision-making process. In this context, the term “stakeholders” could refer to more than just investors. 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