The IASB has issued Definition of Material, amendments to IAS 1 and IAS 8, effective from January 1, 2020 and to be applied prospectively, with early application permitted.
The current definition in IAS 1 is as follows: “Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor.”
Here’s the revised definition and supporting language:
- Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.
- Materiality depends on the nature or magnitude of information, or both. An entity assesses whether information, either individually or in combination with other information, is material in the context of its financial statements taken as a whole. Information is obscured if it is communicated in a way that would have a similar effect for primary users of financial statements to omitting or misstating that information.
- The following are examples of circumstances that may result in material information being obscured:
- (a) information regarding a material item, transaction or other event is disclosed in the financial statements but the language used is vague or unclear;
- (b) information regarding a material item, transaction or other event is scattered throughout the financial statements;
- (c) dissimilar items, transactions or other events are inappropriately aggregated;
- (d) similar items, transactions or other events are inappropriately disaggregated; and
- (e) the understandability of the financial statements is reduced as a result of material information being hidden by immaterial information to the extent that a primary user is unable to determine what information is material.
- Assessing whether information could reasonably be expected to influence decisions made by the primary users of a specific reporting entity’s general purpose financial statements requires an entity to consider the characteristics of those users while also considering the entity’s own circumstances.
- Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide information directly to them and must rely on general purpose financial statements for much of the financial information they need. Consequently, they are the primary users to whom general purpose financial statements are directed. Financial statements are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently. At times, even well-informed and diligent users may need to seek the aid of an adviser to understand information about complex economic phenomena.
The two main points are unchanged – in general terms, that an item’s materiality depends on its capacity to influence decisions made on the basis of the statements, and that no single bright line test exists for making this determination. Beneath that broad similarity, the IASB’s proposal reflects a painstaking fine-tuning of nuance and implication. I’ll just bring out a few of the underlying considerations:
- The existing reference to information that “could…influence” the economic decisions of users may be regarded as too high a threshold, in that “almost anything ‘could’ influence the decisions of some users of the financial statements, even if such a possibility were remote.” The revised reference to what “could reasonably be expected” to carry such influence should place some real-world practicality around the determination (on the face of it, this change alone might make it easier to assess vast passages of potential disclosure as not being material).
- Similarly, the proposed reference to “primary users” rather than simply “users” should counter any possible concern about needing to consider all possible readers of the statements and how they might react to a particular item of information. The language in the penultimate paragraph above, about the characteristics of users, reflects the current language in the conceptual framework.
- The new reference to “obscuring” information chimes with the existing wording in IAS 1.30 that an entity “shall not reduce the understandability of its financial statements by obscuring material information with immaterial information.” Under the current definition, an issuer might argue (albeit not very scrupulously) that a key piece of narrative information is appropriately disclosed even if it’s buried in the middle of a large block of insignificant drivel. The revised version makes it clearer that financial statements might be considered materially misstated on such a basis. The final version contains more commentary on this point than there was in the exposure draft, reflecting the comments received.
As in the exposure draft, it may seem rather contradictory that the basis for conclusions states that “the amendments will improve understanding of the definition of material” and yet that at the same time, the IASB “concluded that the amendments do not change existing requirements substantively.” The implication there seems to be that while the current language may cause some confusion or inefficiency on occasion, preparers usually end up getting to the right place. But perhaps that’s not correct – if “disclosure overload” is a problem, as we’re so often told, then perhaps the alleviation of that problem actually should be seen as a substantive change to existing requirements. Of course though, that won’t be the fruit of these changes alone, but rather of the multi-pronged effort encompassing the already-issued practice statement, the previously-implemented amendments to IAS 1, the IASB’s frequent outreach on the topic, and (one hopes) of widespread cultural change taking root over time.
The opinions expressed are solely those of the author