Not every accounting error, fluctuation or financial disclosure carries the same level of importance. In financial reporting, the concept of materiality helps determine which issues are significant enough to influence the decisions of lenders, investors and other stakeholders, and which are unlikely to change the overall picture. Understanding how materiality is evaluated can help business owners focus on what matters most, prepare for audits and make more informed financial decisions.

What Makes Financial Information Material

Under U.S. accounting standards, financial information is “material” if omitting or misstating it could influence users’ decisions based on the financial statements. Auditing standards apply the same principle, focusing on whether misstatements — individually or in the aggregate — could reasonably influence users’ economic decisions.

Although wording varies slightly across reporting frameworks, the underlying principle remains consistent: Materiality is user-focused and requires professional judgment informed by both quantitative and qualitative factors. It’s not a mechanical percentage test.

How Auditors Determine What Matters Most

An audit provides reasonable assurance that the financial statements are free from material misstatement. External auditors rely on their professional judgment to determine what’s material for each company, based on such factors as:

• Size
• Industry
• Internal controls
• Financial performance

When planning an audit, the auditor establishes overall materiality for the financial statements as a whole, often using a benchmark such as a percentage of pretax income, revenue or total assets. The auditor also sets “performance materiality,” a lower threshold used to reduce the risk that undetected misstatements, in aggregate, exceed overall materiality. In some cases, auditors establish separate materiality thresholds for particular high-risk accounts or disclosures.

During fieldwork, materiality affects the nature, timing and extent of audit procedures. It influences sample sizes, risk assessments and which accounts receive more scrutiny. Auditors also evaluate significant year-over-year fluctuations and unexpected trends. For example, if shipping or direct labor costs increased by 30% in 2025, it may raise a red flag, especially if it didn’t correlate with an increase in revenue. Businesses should be ready to explain why costs increased and provide supporting documents (such as invoices or payroll records) for auditors to review.

Auditors may need to reassess materiality if circumstances change from year to year — or even during an engagement. Moreover, auditors must apply significant judgment when evaluating materiality. For instance, a relatively small misstatement may still be material if it masks a trend, affects compliance with loan covenants, triggers management bonuses or involves fraud.

Materiality Beyond the Audit

Materiality also plays a role in other types of accounting engagements:

Financial statement reviews: A CPA provides limited assurance that financial statements are free from material misstatement. The CPA performs inquiry and analytical procedures and reports whether anything came to their attention suggesting the financial statements may be materially misstated. Unlike an audit, a review doesn’t involve detailed testing of transactions or internal controls. However, materiality still plays an important role in designing review procedures and evaluating unusual fluctuations, significant estimates and financial statement disclosures.

Financial statement compilations: The CPA provides no assurance. The accountant presents financial information in the proper format but doesn’t verify its accuracy. Professional standards require the CPA to consider whether the financial statements appear materially misstated or misleading. If information is incomplete, inconsistent or obviously incorrect, the CPA may need to request revisions — or, in some cases, withdraw from the engagement.

Why Materiality Matters to Your Business

The concept of materiality also has strategic implications for business owners and their internal finance and accounting teams. Not every minor bookkeeping error requires immediate correction, and not every fluctuation deserves the same level of attention. Understanding materiality helps you focus attention where it matters most — on the accounts, estimates and risks that could meaningfully affect profitability, cash flow, debt covenant compliance and overall business value.

Rather than striving for perfection in every minor detail, management can use materiality as a decision-making filter. It supports smarter allocation of accounting resources, more effective internal controls and clearer financial reporting. A shared understanding of what’s truly material also strengthens discussions with lenders, investors and other stakeholders by keeping the focus on the issues that influence business outcomes.

Putting Materiality into Practice

Materiality is more than an accounting concept — it’s a practical tool for better financial decision-making. Proactively evaluating significant changes in your financial statements and understanding what matters most to your stakeholders can strengthen your reporting. Look to our audit pros for guidance on materiality considerations and other financial reporting matters that can affect your business.