In this blog, Tim Wyatt from Wyatt & Co Chartered Accountants, explains the concept of materiality in charity accounting. Tim has many years of experience working with churches and charities across the UK.
You might have heard the term materiality in the context of accounting, or perhaps you’ve been told, “don’t worry, it’s immaterial”. To find out what that means, read on.
What is materiality?
In accounting, materiality refers to the weight, or influence, of a particular amount or transaction on the overall narrative of a set of accounts. The Charity Commission says:
“An item is material if its inclusion or exclusion from the accounts would be likely to change a reader’s view about the accounts. Normally the larger the item the more material it is likely to be.”
This video explains the concept of materiality further:
What amounts count as material?
Well as ever, it depends! The challenge with materiality is it’s subjective. There isn’t necessarily an absolute value to which you can attach a figure. What is considered small for one organisation might be large for another.
For example, some charities produce their accounts in rounded thousands, whilst others have an income of just a few thousand pounds. Some schools of thought work on a percentage, but as you’ll see below, it’s not just the amount which is important. You should contact your Independent Examiner if you’re unsure if something is material.
Examples of materiality
If you have an error in your charity accounts which is small, it usually will not have a significant effect on the overall picture of the accounts to the reader.
Imagine a £10 donation being coded to your 9am service category when it was actually collected at the 11am service. Most likely, both categories are brought together into a wider “donations” line in the final accounts. Even if you report on donations by service in a note to the accounts, a £10 discrepancy won’t cause many issues.
However, if you were to have a large or significant error or omission from the accounts in terms of value, it can have a significant effect on the reader of accounts. It changes how they will interpret the accounts and see the overall picture, and therefore make decisions from it.
An example of this might be a charity with £300,000 annual income that has a £30,000 invoice to pay for building work. Let’s say this invoice was dated in the year of the accounts in question, but not actually paid until the following year and not mentioned in the accounts. In this case, the charity is large enough (income > £250,000) to be accounting on an accruals basis. Additionally, this invoice should have been accrued for as Accounts Payable. Due to the size of the charity, this amount would be considered material. However, if the charity was much larger, with an income of £700,000, a £20,000 error would be less material. Smaller charities who prepare accounts on a receipts and payments basis don’t add accruals, so this example would not apply.
Another example might be netting off a large amount of expenditure as negative income – consequently understating both the income and the expenditure of the organisation.
These last two examples describe when something could have a significant effect on the reader of the accounts, changing their view of the accounts narrative. That is when something would be material.
Is it just the amount that makes something material?
In one word, no.
A transaction or amount can be material even if the error or omission is small in value or seems trivial. That is what we call material by nature.
In charity accounts, certain areas of the disclosure notes may be material by nature. This is when an error or omission is not very large in terms of its numerical value. But it could have significant consequences for the reader of accounts when they see it. It might even completely change the view of how the accounts come across.
Here are some examples of errors and omissions that are material by nature:
- A small amount of undeclared expenditure. Though small in value, when correctly included, it changes the overall story of the financial activity from a small surplus to a small deficit.
- When a charity’s total balance sheet is close to the minimum reserves target, a small change in financial activity can have a large effect on the narrative of the accounts.
- If there’s an omission on a related party or trustee’s expenditure note that might be sensitive. Learn more about related parties in this blog.
- If a conflict of interest is not declared such as a trustee receiving benefits from your charity. Read more about managing conflicts of interest in this blog and how ExpensePlus can help you.
- If a charity has spent money from a restricted fund that isn’t in line with the restriction, so should have been spent from their general fund, this is against the principles of fund accounting. Learn more in this blog on fund accounting.
Whatever the amount, these are examples of errors or omissions that are material by nature, even if the value of that expenditure is correct.
Summary
You can have errors or omissions that are material by value. You also need to be aware of errors and omissions that are material by nature. Both of these may affect the reader’s view of your accounts.
You should always contact your Independent Examiner if you discover an error or omission in your accounts or are unsure if something is material. They can advise you on any disclosures or corrections which might be necessary in your next accounts.
ExpensePlus is a cloud-based fund accounting software package designed for churches and charities. ExpensePlus makes managing fund accounts simple and straightforward.
