In a general context, a material can refer to the substances or components used in the creation or manufacturing of a product. Materials can be raw materials, which are used in the initial production process, or they could be more processed materials that are used in later stages of production.
For instance, in the construction industry, materials would include items like concrete, steel, bricks, glass, wood, and so forth. In manufacturing a car, materials would encompass steel, glass, plastic, and more. For a clothing manufacturer, materials could mean fabrics like cotton, polyester, silk, etc.
In the context of accounting and business, the term “material” can also refer to the significance of an amount, transaction, or discrepancy. An item is considered material if its inclusion or omission would influence the decision of a reasonable person. Materiality is a concept used in auditing and accounting to determine the importance and influence of an amount, transaction, or discrepancy on the company’s financial statements.
To put it in perspective, if a publicly-traded company misstates its revenue by $1,000, that’s likely not a material amount given the scale of the business. However, if the same company misstates its revenue by $1 million, that could be considered material because it could influence decisions made by investors, creditors, or other stakeholders. The thresholds for materiality vary depending on the size and nature of the company.
Example of Material
Let’s start with a straightforward example of materials in a manufacturing context:
Suppose we have a company called “Wooden Creations” that manufactures wooden furniture. The primary raw material they use is different types of wood, such as oak, mahogany, and pine. They would also use other materials like nails, screws, glue, varnish, etc. In this context, these are the materials necessary for Wooden Creations to create their products.
Now, let’s consider an example from an accounting perspective:
Consider a large multinational corporation, “TechGlobal Inc.”, with total assets of $10 billion. Suppose TechGlobal Inc. made an accounting error that resulted in an overstatement of assets by $10,000. Even though $10,000 is a significant amount of money in everyday life, when you compare it to the total assets of $10 billion, it’s not very significant – it’s only 0.0001% of the total. In this context, the $10,000 error would likely not be considered “material” because it wouldn’t substantially affect the decisions of anyone relying on the company’s financial statements.
On the other hand, if TechGlobal Inc. overstated its assets by $100 million, that error would likely be considered material, as it represents a much more significant portion of the total assets and could potentially influence the decisions of investors, lenders, and other stakeholders. The materiality concept in this context helps auditors, accountants, and financial statement users determine whether an error or omission is significant enough to impact the company’s financial reporting and users’ decisions.