How to Calculate Materiality?
Materiality refers to the significance of an item, transaction, or misstatement to the decision-making process of stakeholders, especially in financial reporting and compliance contexts.
The Securities and Exchange Commission (SEC), Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) lack specificity in defining the criteria for materiality. Therefore, organizations have leeway to define it on their own. The lack of authoritative definition for materiality is not unique, since the concept of risk appetite, risk tolerance and risk threshold also suffer from nebulous definitions at many organizations. For an item to be considered material, the control deficiency, risk, threat or incident generally must meet one or more of the following criteria where the potential financial impact is:
- ≥ 5% of pre-tax profit;
- ≥ 5% of revenue;
- ≥ 1% of total equity; and/or
- ≥ 0.5% of total assets.