Gift Card Accounting

Managing Materiality

Accounting information is material if its omission or misstatement would mislead investors. In other words, if theres 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 dont 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 companys income will rise significantly in the future, then perhaps it is a good investment. Similarly, if you predict that a company wont 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.