Accountants have wrestled with the question of materiality forever and often have used a “5 percent rule” when it comes to determining materiality. In short, the theory behind this “5 percent rule” is that investors would not be unduly influenced by variances in net income or income statement line items that are under 5 percent. Most would agree that determining materiality it not a cut-and-dried deal.

This “5 percent rule” of materiality most often is applied to financial statement representations and disclosures. But there are plenty of business events where materiality matters. And when it relates to fraud, “what does it really mean?”

You can find the definition of materiality below in the glossary of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Concepts No. 2, Qualitative Characteristics of Accounting Information:

“. . . the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.”

One can interpret and apply this definition to any number of circumstances that do not relate just to financial statements. Depending on the nature and size of particular business transactions, it can apply to everything from billing, accounts payable transactions, and budget preparations to general ledger activities.

And remember, there are a lot of perspectives that must be taken into account when considering “materiality,” including Sarbanes-Oxley, Foreign Corrupt Practices Act, SEC Staff Accounting Bulletins, FASB pronouncements, and a myriad of federal, state, and local statutes. Some statutes and regulations set the dollar bar very low for determining what is material when it comes to fraud. Some of these bars are so low as to be considered “zero tolerance.”

So when it comes to fraud, what do you think?

If someone makes multiple $50,000 fraudulent journal entries that result in financial statement misrepresentations, I bet you would agree that this is material fraud and should not be tolerated.

What if someone decides to record an adjusting journal entry of $50,000 that is not over 5 percent of net income? But it just happens to favorably impact earnings by enough to meet planned earnings goals and trigger higher bonus payouts. Is that OK?

How about when someone routinely uses the corporate p-card to pay for $100 in personal expenses and does not reimburse the company? It’s only one person. Is that immaterial and not a big deal? How about if “everyone does it”? Is that now heading toward a “materiality” that demands some attention and action?

So has your organization even considered this question? When it comes to fraud, do you have materiality guidelines and thresholds defined as to what you can “tolerate” versus what you cannot accept? ###