Making materiality judgments – a practice statement to make perfect, part one

As we discussed previously, the IASB has issued an exposure draft Definition of Material, with comments to be received by January 15, 2018, and (in final form) Practice Statement 2 Making Materiality Judgments.

We’ve already looked at the proposals in the exposure draft. Moving on, the practice statement is non-mandatory guidance developed by the IASB – the introduction specifies that “its application is not required to state compliance with IFRS Standards,” and so it doesn’t have an application date as such. It sets out the following possible approach to the assessment of materiality in preparing the financial statements:

  • Step 1—identify. Identify information that has the potential to be material.
  • Step 2—assess. Assess whether the information identified in Step 1 is, in fact, material.
  • Step 3—organize. Organize the information within the draft financial statements in a way that communicates the information clearly and concisely to primary users.
  • Step 4—review. Review the draft financial statements to determine whether all material information has been identified and materiality considered from a wide perspective and in aggregate, on the basis of the complete set of financial statements.

I won’t go into detail on those steps, or on the document’s discussion of the general characteristics of materiality – rather, I’ll just pick out a few items I found particularly interesting, at least based on my own experience. From a day to day perspective, the most valuable sections of the practice statement may be those which provide ammunition against the relentless triviality of much of what makes its way into the notes, for example:

  • When preparing its financial statements, the entity assesses whether disclosures specified in IAS 16 are material information. Even if PP&E is presented as a separate line item in the statement of financial position, not all disclosures specified in IAS 16 will automatically be required. In the absence of any qualitative considerations, if the amount of contractual commitments for the acquisition of PP&E is not material, the entity is not required to disclose this information.

One rather regrets the timidity of that example though – why for instance couldn’t it have specified that the entire reconciliation of movements in property, plant and equipment might not be material, rather than just one of the related disclosures? Likewise, the document addresses the common notion that every related party transaction is in some sense material, however insignificant the amounts involved, for instance:

  • In the current reporting period, the entity sold an almost fully depreciated vehicle to company DEF. The entity transferred the vehicle for total consideration consistent with its market value and its carrying amount. Company DEF is controlled by a member of the entity’s key management personnel. Hence, company DEF is a related party of the entity… (the entity) concluded that its impact was too small to reasonably be expected to influence primary users’ decisions, even when considered with the fact that the transaction was with a related party.

It’s better than nothing, but again, it’s a shame that the IASB chose such a comically unimportant example, compared say to crafting an illustration in which a transaction might be considered immaterial even though the consideration transferred couldn’t be objectively determined as representing market value.  The problem with these two overly tentative illustrations might be that they tend to imply by omission that almost everything else that goes in the notes probably is material.

Another common example of excessive disclosure relates to old information from the comparative period, or from even earlier than that. The practice statement provides the following illustration:

  • An entity disclosed, in the prior-period financial statements, details of a legal dispute which led to the recognition, in that period, of a provision. In accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets the entity disclosed in the prior-period financial statements a detailed description of uncertainties about the amount and timing of possible cash outflows, in respect of the dispute, together with the major assumptions made concerning future events. Most of the uncertainties have been resolved in the current period, and, even though the liability has not been settled, a court pronouncement confirmed the amount already recognized in the financial statements by the entity.

In these circumstances, the practice statement says the “entity may not need to reproduce in the current-period financial statements all of the information about the legal dispute provided in the prior-period financial statements… Instead, information about those uncertainties might be summarized and updated.” The broad point, again, goes to predictive value. Some practitioners seem to take the view that if certain disclosure was material to the balance sheet at December 31, 2016, then it must be equally material as at December 31, 2017, when the balance sheet is reported again as a comparative.  But some of that disclosure was only relevant at the time because of the inherent impossibility of knowing what would happen during 2017. If actual knowledge of 2017 now makes the information redundant, then what’s the point of keeping it?

More on the practice statement next time…

The opinions expressed are solely those of the author

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