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

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.

Last time we looked at some extracts from the practice statement. Let’s continue with that now.

In the exposure draft of the practice statement, the IASB proposed specifying that: “…if management intentionally misstates items to achieve a particular presentation or result it has done so presumably because it thinks that particular presentation or result could reasonably be expected to influence the decisions of the primary users of the financial statements and such misstatements are material,” and expanded further on the concept with an example. I wrote a whole post on this aspect of the proposals, questioning whether “deliberately misapplying a standard is always inherently more egregious than doing so out of ignorance or carelessness” and concluding that at the very least, more expansion of the concept was needed. I overlooked in that post though that IAS 8.41 already refers briefly to the concept, saying that “financial statements do not comply with IFRSs if they contain either material errors or immaterial errors made intentionally to achieve a particular presentation…”

In the final version, the IASB just echoes what IAS 8.41 already says, without expanding further. The difference is that IAS 8.41 doesn’t say that immaterial errors may become material when they’re made intentionally; it just says that such errors should be corrected regardless. This still leaves some doubt about how to apply the concept – does it matter that an entity deliberately makes immaterial errors to “achieve a particular presentation” of (say) the balance sheet, if its motives for doing that are entirely internally driven, and couldn’t influence the economic decisions that users make on the basis of the statements? – but at least the practice statement doesn’t open up any new questions in this regard.

In another of my original articles, I set out various instances where focusing on materiality might lead to disclosing more information than issuers might provide at present. Here’s one such example from the final practice statement:

  • In some circumstances, if an entity is not exposed to a risk to which other entities in its industry are exposed, that fact could reasonably be expected to influence its primary users’ decisions; that is, information about the lack of exposure to that particular risk could be material information.

The final version preserves an illustration from the exposure draft: “An international bank holds a very small amount of debt originating from a country whose national economy is currently experiencing severe financial difficulties. Other international banks that operate in the same sector as the entity hold significant amounts of debt originating from that country and, hence, are significantly affected by the financial difficulties in that country.” In the example provided, disclosure of this situation is material on the basis that it “provides the entity’s primary users with useful information about how effective management has been at protecting the bank’s resources from unfavourable effects of the economic conditions in that country.” I said before I could imagine some practitioners (those who are fond of identifying “slippery slopes”) being a bit concerned at this, in that it seems to suggest an obligation for preparers to identify all the risks and conditions that market participants might conceivably think are applicable to the company, and then to explicitly assure them that these risks and conditions aren’t actually applicable, which might seem like an onerous task by any measure. Perhaps everything hangs on the key words “in some circumstances” – that is, if it takes too much work to determine how this concept might apply in any particular instance, then perhaps it isn’t one of those circumstances.

The exposure draft also seemed in some instances to blur the line between the financial statements and the MD&A, for instance: “…a fall in sales of a major product from a material amount in the prior year to an immaterial amount in the current year may be a material change that should be separately disclosed or identified in the current year.” This seems to be more a matter of analyzing the numbers than of fairly presenting them. Anyway, that example from the exposure draft doesn’t appear in the final practice statement, and the concern about the blurred line doesn’t seem as likely to arise. Having said that, the final statement still takes pains to illustrate how a materiality judgment may lead to disclosing information not specifically required by a standard, for example through a scenario where “even though not specifically required by IAS 36, the entity concludes that its assumptions about the likelihood of national enactment of regulations to reduce the use of carbon-based energy, as well as about the enactment plan, constitute material information (in the context of its assessment of a particular tangible asset’s recoverability).”

It will be a valid outcome if the practice statement occasionally prompts issuers to disclose more than they would have otherwise. But the IFRS Foundation has made it clear enough that the main measure of success will be in whether they collectively disclose less…

The opinions expressed are solely those of the author

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