Materiality in financial statements – at least we’re not the US!

As we discussed here, the IASB has issued for comment an exposure draft of a proposed practice statement Application of Materiality to Financial Statements, with comments to be received by February 26, 2016.

In the last three articles, we covered some areas where respondents to the exposure draft might possibly have concerns. Those concerns though are likely to constitute the mildest of caveats, compared to the current debate on the same topic in the US. In September, the FASB issued an exposure draft of proposed amendments to its Statement of Financial Accounting Concepts, with comments due by December 8, 2015. The exposure draft proposes to delete the current statement that information is material “if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity,” and to replace it with a statement that: “Materiality is a legal concept. In the United States, a legal concept may be established or changed through legislative, executive, or judicial action. The Board observes but does not promulgate definitions of materiality.” It goes on:

  • “Currently, the Board observes that the U.S. Supreme Court’s definition of materiality, in the context of the antifraud provisions of the U.S. securities laws, generally states that information is material if there is a substantial likelihood that the omitted or misstated item would have been viewed by a reasonable resource provider as having significantly altered the total mix of information. Consequently, the Board cannot specify or advise specifying a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation.”

The Board states that it intends this change to address existing “uncertainty or confusion” between its current definition of materiality and the legal standard. It acknowledges that the change would cause a difference from IFRS, noting that convergence “is not possible in this circumstance because the IASB’s definitions of materiality are not consistent with the legal concept of materiality in the United States. Some stakeholders also have observed that the IASB’s definitions of materiality generally would require disclosure of more information than would the legal concept of materiality in the United States.”

Some commentators think that there’s little real “uncertainty or confusion” attached to the current state of things, and that the real object here is to allow preparers and auditors to base their materiality judgments on legal opinions, with a resulting decline in the overall quality of disclosure. Here’s Tom Selling in The Accounting Onion:

  • “Let’s not beat around the bush. Every one of the justifications put forth by the FASB for them are nothing more than a thinly veiled obeisance to special interests:
  • “Respondents … have requested these amendments to eliminate inconsistencies between the framework and the legal concept of materiality.” 
  • “Respondents” is FASB-speak for issuers and their auditors.  Of course these “respondents” would prefer a strictly legal definition of materiality!  That way, when sued by misled investors, they will smugly claim that they relied on some “independent” legal opinion (paid for by the misled shareholders) that an omitted disclosure was not “material” as defined by previous Supreme Court cases.
  • Setting aside the obvious circular logic, everybody knows that strict application of the law does not always result in “fair presentation.” Under the bus with the cornerstone of the auditor’s report!
  • “Respondents to past requests for comments on other proposed Accounting Standards Updates often have stated that while certain proposed disclosures may be relevant to other entities, those disclosures do not provide relevant information in their own circumstances.” 
  • Why wouldn’t the FASB simply remind these respondents that there is nothing in current GAAP, the PCAOB’s auditing standards or the securities laws, that bars an issuer from omitting immaterial disclosures?”

Here’s a similar commentary from David Dayen in the Naked Capitalism blog:

  • “The Supreme Court’s materiality standard is applied under SEC Rule 10b-5, a rule that targets securities fraud. It comes from a 1988 case, Basic v. Levinson, which determines materiality as whether a reasonable investor would have viewed whatever was undisclosed as something that would have altered the “total mix” of information about the company.
  • That’s pretty similar to the current FASB standard. But think about it. Basic v. Levinson defines when a lack of disclosure rises to the level of securities fraud. That’s necessarily a higher standard than the positive obligation to disclose. “I want to know more as an investor than what it would take for the thing to be a fraud,” said Damon Silvers, policy director at the AFL-CIO. The legal standard, then, creates a higher threshold for materiality – though nobody really knows how high – subject to the whims of the company and its auditor. And every time the courts tinker with the standard – and we know the pro-corporate tilt of this Court – the materiality standard would change.”

Dayen says: “for this proposal to bubble up from committees and individuals with clear ties to big business makes it look suspiciously like (SEC Chair) Mary Jo White and her minions want to undermine the SEC from within.” I don’t know if that’s true of course, but it’s pitifully sad when financial reporting issues take on the air of conniving, self-interested politics (whether because indeed that’s what it is, or because of inept communication). Whatever one might think of the IASB’s proposal, we can be deeply relieved that the conversation is entirely about concepts and parameters, not about the depressing machinations of people and institutions.

The opinions expressed are solely those of the author

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