Applying the Materiality Concept: The Case of Abnormal Items

Abstract

Materiality is a key concept in accounting theory and practice. Yet differing views exist in regard to the practical application of the materiality concept amongst preparers, auditors, users of financial reports and regulators (ESMA/2011/373). Unlike International Accounting Standards, in Australia AASB 1031 Materiality addresses materiality thresholds. The pre-2000 period, when Australian firms were required to separately disclose abnormal items in their financial reports, provides a unique opportunity to explore how the concept of materiality was applied. Abnormal items were considered abnormal by reason of their size and effect on operating earnings. We investigate whether immaterial or marginally material items were classified as abnormal, and whether materiality thresholds were consistently applied to different types of abnormal items and over time. Findings show almost a quarter (22.94%) of abnormal items were immaterial for which the overall mean was only 2.54% of the baseline earnings before abnormal items. Results are consistent when abnormal items are classified into the four predominant types by which described in financial reports and when further dissected into the forty categories by which they were themed. The outcomes of this analysis inform the current regulatory debate concerning the inclusion of immaterial items in financial reports which may mislead users (FRRP 2013) and the IASB materiality project (2013).