Managing Materiality

Accounting information is “material” if its omission or misstatement would mislead investors. In other words, if there’s a piece of information that investors need to know, then that information is material – it makes a difference.

Information can be material in size or importance. In size, materiality is all about the amount. A large amount of money – relative to the size of the company – is material. A small amount of money – relative to the size of the company – is not material. For example, some companies round their financial statement figures to the nearest thousand dollars (or even million dollars). They state a $500,000 expense  as $500 “in thousands.” These companies do not consider amounts less than a thousand dollars to be material.

Some items may be small in amount, but large in importance. For example, suppose that the president of the company had a $500 expense which in dollar amount was not material. What was the expense? He bribed a public official. Since this expense is illegal, it is considered material, even though the amount itself is not material.

Why is materiality important? Because accountants don’t want to bring on investor overload. Too much immaterial information would swamp investors with data that would confuse them and distract them from the truly important information.

 

Understanding confirmatory value

In accounting, information has confirmatory value when it helps users to confirm or adjust prior expectations. But why is confirmatory value an important attribute for accounting information to have?

People read accounting financial statements in order to create predictions about the future. They want to predict future dividends and that the company will be able to make interest and principal payments. To make these predictions, they often make predictions about future net income. The value of information in making predictions is called predictive value. This information can then be used to make investment decisions. If you predict that a company’s income will rise significantly in the future, then perhaps it is a good investment. Similarly, if you predict that a company won’t be able to pay interest on its bonds next year, then you probably should not invest in its bonds.

Now please bear with me while I make an analogy. How does a marksman learn to hit a target? With practice. Take a shot. How close to the bulls eye did you get? Take another. Was that better? And another. A good marksman will need many many hours of practice to learn how to shoot.

The same goes for financial analysts. A financial analyst is constantly making predictions, and then – after the fact – gauging their accuracy. Make a prediction. Then see what happened. Make another prediction. How close to the bulls eye did you get? Try again, and again. Confirmatory value is the value of information to gauge how accurate your predictions are – so that you can make more accurate decisions in the future.

 

Relevance in accounting

Accounting information is relevant when it is capable of making a difference in a decision.

Suppose that you’re trying to decide what to eat for dinner: A hamburger? Or a salad? What information is relevant to your decision? The price of each meal, perhaps. And consider the number of calories, too. Do you have the food ready to make, or do you need to run to the store? All of this information will help you to decide what to eat.

On the other hand, some information is not relevant. You decided to wear blue shoes today. Not relevant.

In accounting, information is used to make investment decisions – and investors who use that accounting information are interested in predicting future income, interest payments, principal payments, and dividend payments. Relevant information helps them to make these decisions, while irrelevant information does not. Here are three specific attributes of relevant information:

  1. Relevant information has predictive value. It helps investors to predict what will happen in the future.
  2. Relevant information has confirmatory value. It helps investors to assess the predictions, and therefore to improve their skills at making predictions.
  3. Relevant information is material. If you didn’t know about it, you might make a mistake.
 

When does accounting information have “predictive value?”

In accounting, information has “predictive value” when it can be used to help investors to form expectations about the future.

Let me give you some background. The whole point of accounting information to help investors to make decisions about loaning a company money or buying its stock. How are investors supposed to make these decisions? When you think about it, investors really want to know about the future. If you buy this stock, what are the future dividends likely to be? If you loan a company money, will it be able to pay interest and principal on time? Here’s the problem: while you want to know about the future, financial statements only tell you about the past. You have to use last year’s income statement and balance sheet in order to figure out what is likely to happen in the future – the prospects of paying dividends, interest, and principal in the future. That is predictive value.

Financial statements have predictive value when they help you to predict the future. This enables you to estimate future dividends, or the likelihood of interest and principal being paid to you on time.

 

What is the economic entity assumption?

The economic entity assumption is one of four assumptions underlying financial statements. It says that you can identify economic activity with a particular unit of accountability.

Put another way, the economic entity assumptions says that certain transactions are “inside” a business, while other transactions are “outside” of the business. Suppose that you run a candy store. Buying candy in order to resell it is “inside” of your business. Your intent is to earn a profit. On the other hand, buying candy in order to eat it is “outside” your business – your intent is to eat candy.

In taxes, a businessperson must be very careful to segregate personal expenses (“outside” the business) from business expenses (“inside” the business). Taxing authorities do not like when businesses deduct personal expenses. Ask Dennis Kozlowski.

Many businesses are actually combined “groups” of businesses. A corporation might own several dozen other corporations, each representing a different line of business. Each corporation may be its own economic entity, reporting its own financial statements. The combined group of corporations may also be an economic entity, reporting its own financial statements.

 

Improve your Excel Skills Now with these 5 Tips

Microsoft’s Excel program has been an integral part of the regular office-goer’s life. One part of Microsoft’s Office Suite – Excel – is an extremely feature-rich software program that has proven itself to be indispensable time and again. Whether it is for drawing up a quick report, chalking up some financial sheets, or even running some highly repetitive functions, Excel always comes to the rescue. 

However, the majority of the people who use Excel, even on a regular basis, happen to be unaware of some options, methods, and general features that the application possesses . These can boost productivity and make life a lot more easier when working on lengthy spreadsheets. Take a look at these tips to speed up your Excel tasks:

Top 5 TipsThere are many hidden features in Microsoft Excel that are not well known. These features can prove to be highly beneficial. Here are the top five tips that we found to improve productivity and functionality when using Microsoft Excel:

• Tip 1: Using Excel Functions in a Jiffy (Even the Unknown Ones)

This tip tells you how to quickly find and apply the formula that you need at the click of a button. Clicking on the Insert Function button is the simplest way to get things started. This button can be found as an “Fx” symbol on the toolbar. Clicking on it allows the user to not only apply a function, but also to search for one in a list or in a categorized format.

Once you find the right formula, summon a wizard to make the process of applying the formula that much easier.

• TIP 2: Using the IF Statement in an Easier Way

The IF statement is one of the most commonly used conditional qualifiers in Excel. It allows the cell to contain content based on the validation of some previous entity. This function may be used in the simple IF(if this condition is true, then return this, or else do this) format of usage, but also other ways for more complex conditions and for multiple conditions too, such as : IF(XYZ(C1<=0,C2>=20),”Yes”,”No”).

• TIP 3: Dealing with Multiple Worksheets

When working on an Excel document that contains multiple worksheets, we have often felt the need to compare the content of both sheets. Very few people know that there is an option to do this automatically. In the View tab, click on “new window”, and the click on “Arrange All>Tiled”, we can tile the sheets side by side.

• TIP 4: Comments for Specific Cells

Often, when working on documents that may change several hands, we find the need to define the content of specific cells in the worksheet, or add information that may be needed for others to effectively contribute to the document. In such cases, the document validation option can be used. With this option, a default value can be made to appear in the cell at all times if the cell content is not correctly added, or is wrongly formatted.

• TIP 5: Hide Unnecessary Content

Hiding data that is not necessary to be visible to users is now quite easy, thanks to grouping. To group and hide unnecessary columns, all that the user has to do is chose the columns needed to be hidden, and select “Group” from the data ribbon. The grouped columns then can be hidden or made viewable by the click of a button, on the outline.

Article contributed by Carlo Pandian, freelance writer and community manager at Filtered. He is interested in productivity, management and technology. Find him on Twitter @carlopandian
 

My new Introduction to Excel (YouTube)

I’m proud to announce the first video of my Introduction to Excel series. This series is designed to give you the basic tools you need to get up and running in Microsoft Excel.

Here are the videos released so far:

Part 1: http://youtu.be/HPLuvEL3fNw

Part 2: http://youtu.be/ckoxo6xCvik

Part 3: http://youtu.be/DjOuAO1GDy8

Subscribe to my YouTube channel to received new videos as they come out.