A search that brought someone to my blog over the weekend gave me the idea for this post. Immateriality is a concept in accounting that amounts to “too small to matter.” Think of a company with $100 million in sales each year. If they made a mistake in recording their sales last year, and the number was really $99,950,000 (an error of $50k), would it matter?
Probably not. Whether sales are $50k higher or lower for a company with sales of $100 million really…. it’s just not a big enough difference to matter.
So it goes when the auditors are looking at financial statements and analyzing accounting transactions. The find errors or other problems, but many times they’re too small to really matter, so the auditors do nothing about them.
But the issue of fraud raises some interesting points. The accounting rules say that in order for something to be material to the financial statements, we have to consider more than just the quantitative value. We can’t just look at the dollar amount and say “Pass, immaterial.”
We must also look at the qualitative aspects of the issue. So let’s say we find a $50k fraud at the company mentioned above. The dollar amount will still be immaterial. But, the facts surrounding the fraud can make it material. What if that (relatively small) fraud is being committed by the CFO or CEO? Do you think shareholders would want to know about that? Would it be important to them?
I submit to you that any fraud by upper management is material, and here’s why. First, a fraud indicates a state of mind and a personal code of ethics. I don’t care how small a fraud is, it still indicates the executive’s willingness to deceive. Second, almost all frauds start small. What starts as a minor theft, however, can quickly grow to a material fraud in no time. Companies need a zero tolerance policy toward fraud, and that means discipline for any size fraud committed by any employee.
So basically, there is no such thing as an immaterial fraud. When you look at the statistics about fraud and you examine the circumstances surrounding each individual fraud, you see that there is almost always “material” information about the fraud that makes it bigger than just the dollar amount.