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Chapter 2: Question 5Q (page 61)

How is materiality (or immateriality) related to the proper presentation of financial statements? What factors and measures should be considered in assessing the materiality of a misstatement in the presentation of a financial statement?

Short Answer

Expert verified

All the material items must be disclosed as per the financial reporting framework and guidelines provided by the accounting standard board.

Based on the significance of a specific item, situation, period, size of misstatement, nature of misstatement, etc., on the financial statement, the item is treated as material or immaterial, and material items are disclosed. All materials items must be disclosed by way of note of amount or fact since any changes will affect the decision and business of the users of financial statements.

Step by step solution

01

Materiality as an Accounting Policy & Proper presentation of financial statements

Accounting policies are certain principles and methods followed for the presentation of financial statements. One important policy is materiality.

Materiality related to the proper presentation of financial statements by

  • Disclosing all material items
  • Usefulness to all stakeholders
  • Avoiding misstatement and misunderstanding
  • Following accounting policy, Accounting Standards, IFRS, Audit Standards, financial reporting frameworks, etc
  • Presenting the statement as per the financial reporting framework.
02

Concept of Materiality & Disclosure Limit

Materiality concept means the financial statements must show a fair view and disclose all the items that may influence the decision of users of financial statements.

Certain limits are provided in case of materiality disclosure, such as disclosing income & expenditure based on 1percent of revenue from operations or 1,00,000, whichever is higher, disclosing the number of shares held by each shareholder when shares are more than 5 percent.

03

General Disclosure of Material Items & Related facts

The following must be disclosed since it’s a material item such:

  • All significant changes or items that have an effect on financial statements and users of financial statements must be disclosed
  • Any change in accounting policy in the preparation and presentation of financial statements also must be disclosed.
  • When an item is found to be material, and the amount is ascertained, then disclose the amount. If the amount is not ascertained, then disclose the fact.
  • If the specific item is not material now but would be material in a later period, then disclose the fact of such changes in a later period.
04

Factors considering Materiality of misstatement

Factors and measures that may be considered in assessing the materiality of a misstatement in the presentation of a financial statement:

  • Misstatement, including any omissions or errors, is considered material if it affects the decision taken by users of financial statements.
  • The size and nature of misstatement also affect the decisions about materiality.
  • The significance of an itemon the particular entity.
  • The presentation of financial statements and the effect of misstatement in such statements.
  • Uncorrected misstatements of the previous period.

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Most popular questions from this chapter

Question: Daniel Barenboim sells and erects shell houses, that is, frame structures that are completely finished on the outside but are unfinished on the inside except for flooring, partition studding, and ceiling joists. Shell houses are sold chiefly to customers who are handy with tools and who have time to do the interior wiring, plumbing, wall completion and finishing, and other work necessary to make the shell houses liveable dwellings.Barenboim buys shell houses from a manufacturer in unassembled packages consisting of all lumber, roofing, doors, windows and similar materials necessary to complete a shell house. Upon commencing operations in a new area, Barenboim buys or leases land as a site for its local warehouse, field office, and display houses. Sample display houses are erected at a total cost of \(30,000 to \)40,000 including the cost of the unassembled packages. The chief element of cost of display houses is the unassembled packages, in as much as erection is a short, low-cost operation. Old sample models are torn down or altered into new models every 3 to 7 years. Sample display houses have little salvage value because dismantling and moving costs amount to nearly as much as the cost of an unassembled package.Instructions

  1. A choice must be made between (1) expensing the costs of sample display houses in the periods in which the expenditure is made and (2) spreading the costs over more than one period. Discuss the advantages of each method.
  2. Would it be preferable to amortize the cost of display houses on the basis of (1) the passage of time or (2) the number of shell houses sold? Explain.

What are the enhancing qualities of the qualitative characteristics? What is the role of enhancing qualities in the conceptual framework?

Revenues, gains, and investments by owners are all increasing in net assets. What are the distinctions among them?

Accounting information provides useful information about business transactions and events. Those who provide and use financial reports must often select and evaluate accounting alternatives. The FASB statement on qualitative characteristics of accounting information examines the characteristics of accounting information that make it useful for decision-making. It also points out that various limitations inherent in the measurement and reporting process may necessitate trade-offs or sacrifices among the characteristics of useful information.

Instructions

a) Describe briefly the following characteristics of useful accounting information.

1. Relevance (4) Comparability

2. Faithful representation (5) Consistency

3. Understandability

b)For each of the following pairs of information characteristics, give an example of a situation in which one of the characteristics may be sacrificed in return for a gain in the other.

1. Relevance and faithful representation.

2. Relevance and consistency.

3. Comparability and consistency.

4. Relevance and understandability.

c) What criterion should be used to evaluate trade-offs between information characteristics?

Do the IASB and FASB conceptual frameworks differ in terms of the role of financial reporting? Explain.

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