The amounts, either in total or individually, are higher and go over the limit of tolerance set by the entity- should be taken as material. This is the primary concept of the materiality concept.
To be more to the point:
“The amounts in the financial statements or, the amounts yet to be recorded in the financial statements, if, are below the tolerance level of the entity (In total or, individually); will not be recorded in the financial statements or, will be taken out of the financial statements. Any amount that is tested through the tolerance level should be treated as related to one particular account. After all the amounts are tested through this technique individually then they should all be tested altogether to check if the limit is crossed regarding the overall balance.”
That is all there is to the materiality concept.
But, the mere definition is not enough to explain everything. So, I will provide some description of the matters unclear at first and then will follow it up with examples.
Tolerance level or, Level of tolerance
The limit set by the entity for any amount to be able to not to be included in the financial statements. This is expressed as a percentage rate most of the times.
XYZ co. has a bad debts account and estimates that any amount which is upto 2% of the total sales, if accrued, even beyond a predetermined time from the time of the sale should be recorded as bad debt.
Now, if they have decided to put a sale amount of Tk. 100 due from the total sale amount of Tk. 10,000 as a bad debt expense after two months, preset tolerance level, will that be alright?
The answer here is – Yes.
Because, the level of tolerance is not crossed, but, the amount is within the limit stated by the entity. So, the entity can’t let the amount to be stated otherwise while there is a set predetermined method for that in place.
This is the usage of tolerance limit.
Now we will go for the example of the materiality concept:
An entity has a balance of Tk. 1000 in their bad debts account and their maximum tolerance level is 3% of total sales for the bad debts expense. Their total sales is Tk. 200,000. If they write this off, will that be fine?
The answer here is yes. Because, we know the relevant account and the tolerance rate. This is also below the materiality level.
Now, if the total write-off is Tk. 500,000 brought up by materiality concept and the total amount is Tk. 16,000,000. So, should this write-off be fine?
The simple answer is no. The reason is that the entity has more to write-off over the materiality level and so that is not permitted.