

Financial Thresholds
Materiality is closely
related to risk
management and
decision-making in
the face of
uncertainty…
This raises the criteria of probability and
magnitude of anticipated events as
applied in risk management. Both
probability and magnitude call for the
application of thresholds in making
materiality judgments. In financial
accounting, preparers and auditors would
independently decide what thresholds
they wish to apply. While quantitative
thresholds are the most practical, this
can also involve qualitative expressions.
As an example, the IFRS literature
includes over 30 different expressions of
probability thresholds. These range from
‘remote’ to ‘probable’ to ‘virtually certain’.
Financial thresholds
At stake in conventional financial accounting is the
possibility of misrepresentations or misstatements,
which can involve errors or omissions from financial
statements and annual reports. The question is in how
far the statements and reports are accurate and reliable
for usage by for example the provider of financial
capital. In addition to human error and bounded
rationality, an ever-present possibility to consider is the
willful misrepresentation of information due to fraud.A
related factor is the timely disclosure of misstatements
once they have been discovered. In for example the
USA, Section 409 of the Sarbanes-Oxley Act of 2002
requires the disclosure of a material event in Form 8-K
 within four days. In Canada, the TSX Timely Disclosure
Policy of 2004 requires listed companies to immediately
disclose material information that could significantly
affect the market price or value of their securities. It
specifies that this includes information related to
environmental and social issues.

In financial accounting and auditing, determining the

threshold level of materiality requires that an
appropriate base level and percentage be decided on.
Traditionally the financial community refers to
accounting variables such as net income (before taxes)
or earnings, revenue, total assets and total debt/equity
as benchmarks. The materiality threshold is defined as a
“A typical financial percentage of that base. The most commonly used base
threshold is in auditing is net income (earnings / profits). Most
commonly percentages are in the range of 5 – 10
5–10 percent of percent (for example an amount <5% = immaterial, >
10% material and 5-10% requires judgment).
earnings… between 5
A more conservative approach and lower percentages
and 10 percent requires would tend to be applied in the case of enterprises that

judgement.” are from high-risk industries, that face high risk of fraud,
that have high accounting risk (history of deficient
accounting and controls), that have high staff turnover
and operate in various locations (e.g. multinational).
When profit before tax from continuing operations is
volatile, other benchmarks such as total revenues (sales)
may be more appropriate to use (e.g. 0.2 – 2 percent of
total revenue). Also, where the organization‘s operating
results are so poor that liquidity or solvency is a real
concern, basing overall materiality on financial position
(e.g. equity) may be more appropriate to use (e.g. 1 – 2
percent of owners equity).

While thresholds tend to be applied to the year being

reported on, the cumulative impact of misstatements
over years and its impact on the earnings trend (over
e.g. 3–5 years) are also important. This is significant
considering the interest of sustainability experts and the
IIRC in the ability to create and sustain value in the
longer term.

Standard international guidance on calculating

materiality, considering agreed thresholds, does not
exist. Individual auditing firms provide guidance to their
 managers on what thresholds to apply.  Research to
date has examined in how far for example more
experienced auditors and ones working for bigger firms
with reputational risks tend to be more conservative in
applying (e.g. a lower percentage) thresholds.

As far as preparers are concerned, their judgment tend

to be influenced by factors such as whether their
industry is more exposed to litigation. The closer the
reporting organization is to break-even results (small
profit / loss), the more sensitive the threshold applied
becomes. At stake therefore is not just the absolute
magnitude of the event involved, but also the severity
of its implications, the positive / negative nature
(direction) of the information, the sensitivity of the
firm’s equity returns to the information (the stock price
reaction) and the impact of the information on the firm’s
default risk (importance to debt-holders). The extent to
which investors or lenders (dis)agree with the
materiality judgments made by preparers or auditors
would be seen, among others, in stock market price or
cost of debt capital reactions. Typically negative
information is expected to have greater impact than
positive information.

Approach

Definitions

Financial Thresholds

Sustainability Thresholds

Context and Climate

Context and Resource Use

Qualitative vs Quantitative Information

Financial vs Non-Financial Information

Aggregation and Conciseness

Key Actors and Target Audience