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HBX Business Blog

Word of the Week: Materiality

Posted by Patrick Healy on January 5, 2016 at 3:13 PM


Materiality. Can you use it in a sentence please? No, it’s not related to the accumulation of physical wealth or some obsession with material possession. That’s materialism. Materiality is a key accounting principle utilized by accountants and auditors as they create a business’s financial statements.

Materiality: an accounting principle which states that all items that are reasonably likely to impact the decision-making of investors must be recorded or reported in detail in the financial statements of the business.

Why does it matter? In essence, materiality is related to significance. Is some transaction or business decision significant enough to warrant reporting to investors or other users of the financial statements? If it is, we say that the information is “material” to the business.

What’s considered to be material will differ based on the size and scope of the firm in question. For example, while a small mom and pop grocer may need to record a small expense for promotional coupons, Whole Foods may not need to record a large one for a similar customer offer. It’s all relative.

Material items can be financial (measurable in monetary terms) or non-financial. So a business might need to report a pending lawsuit to the same degree it reports its revenues. Indeed, of late there has been a big push to include more non-financial material information in financial statements.

For example, with a bigger investor focus on sustainability nowadays, a business might want to include information related to its environmental, social, and corporate governance (ESG) practices to assure shareholders that the business itself is a “green investment.” In fact, as Professor Robert G. Eccles discusses in a recent HBR article, there has even been talk of creating new accounting standards to better measure material information related to sustainability.

Interested in learning more about materiality and other topics in finance, economics, and business analytics?

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