Are immaterial amounts ever material?

By Gary D. Zeune, CPA

According to the Association of Certified Fraud Examiners, the average organization loses 6% of revenue, or $9 per day per employee, to fraud and abuse. Think about how many dollars in sales it takes to recoup that. So why don’t we realize the magnitude of these losses? Because they’re scattered all over the financial statements.

It’s OK, if no one notices

Some employees feel justified in taking advantage of a company. Why? Because times are tough―an employee’s spouse has lost his or her job or the monthly mortgage payment has dramatically increased.  Your employee can’t make the payments and doesn’t want to lose the house. So she starts “borrowing” just enough to make the house payment, promising to pay it back. Then when no one notices the money is missing (can you say poor internal controls?), the employee realizes she doesn’t have to pay the money back.

Immaterial = Material

So when is an immaterial amount material? In Statement on Auditing Standards No. 107 (one of the SAS’s in the new Risk Assessment Standards), FASB Statement of Financial Accounting Concepts No. 2, Qualitative Characteristics of Accounting Information, defines materiality as “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.”

But note there’s NO percentage or dollar amount in the definition. Materiality is in the “eye of the beholder.” In other words, if the user of the financial statements would have made a different decision, then the information was material. For example, if a client has a bank loan covenant requiring $1 million of income to automatically renew the loan, and the client changes the calculation of bad debt expense increasing the bottom line from $980,000 to $1,011,000, the $31,000 change in bad debt expense is material. Why? Because the $31,000 is material to the bank loan officer, who, absent the “adjustment” would not have renewed the loan. In other words, an immaterial amount is material if it accomplishes a material event.

Immaterial ≠ Legal

You are a CPA. Your ultimate duty is not to the client who pays your fees nor to your boss. Your ultimate duty is to the user of your financial statements. Your duty is to do the right thing. That means not letting the little immaterial amounts go that are clearly illegal. Just because an amount is immaterial for financial reporting does NOT mean it’s legally OK. If you’re an auditor, don’t put the $5000 in vacation expenses on the passed adjustments list. The $5000 is an illegal deduction. If you’re the controller don’t write the check to reimburse your boss. Stand your ground and 1099 it. Or set up a receivable. Do something to properly account for it.

Gary D. Zeune, CPA, is a nationally recognized speaker and writer on fraud, and founder of The Pros & The Cons, the nation’s only speakers bureau for white-collar criminals at www.TheProsAndTheCons.com. He teaches fraud classes for the FBI and numerous professional associations, and is the author of The CEO’s Complete Guide to Committing Fraud and Outside the Box Performance. He can be reached at gzfraud@bigfoot.com, or 614.761.8911. To schedule Gary Zeune for a presentation at your office, contact Joan McGloshen, customized training at 800.686.2727 or jmcgloshen@ohio-cpa.com.

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