Defining “materiality”

The concept of materiality is used to determine what’s important enough to be included in — and what can be omitted from — a financial statement. In late October, the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA) voted to finalize a revised definition of materiality in its professional standards.

Materiality and GAAP

Under current U.S. Generally Accepted Auditing Standards (GAAS), misstatements and omissions are considered material if they, individually or in the aggregate, could “reasonably be expected to influence the economic decisions of users made on the basis of the financial statements.” The current definition of materiality was set by the International Accounting Standards Board.

In June 2019, the AICPA issued Exposure Draft: Proposed Statement on Auditing Standards: Amendments to the Description of the Concept of Materiality. It proposed aligning the definition of materiality in the auditing standards with the definition that’s used in financial reporting under U.S. Generally Accepted Accounting Principles (GAAP).

Under existing GAAP, the amended definition of materiality is: “The omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is probable [emphasis added] that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.”

The proposal was approved during an ASB meeting in New York in late October 2019. “The ASB believes that eliminating inconsistencies between the AICPA standards and the definition of materiality used by the U.S. judicial system and other U.S. standard-setters and regulators is in the public interest,” said Ahava Goldman, associate director for audit and attest standards with the Association of International Certified Professional Accountants.

FASB guidance

The ASB’s materiality project comes on the heels of the decision by the Financial Accounting Standards Board (FASB) to return to its original definition of materiality, which was in effect from 1980 until 2010. This definition differs from the international definition.

Under the ASB’s new definition, “Misstatements, including omissions, are considered to be material if, in light of surrounding circumstances, it is probable [emphasis added] that the judgment of a reasonable person relying on the financial statements would be influenced or changed by the misstatements, individually or in the aggregate.”

“Because the revised [ASB] definition is aligned with the FASB [definition], the ASB believes it is substantially consistent with current firm practices with respect to determining and applying materiality in an audit or attest engagement and accordingly the amendments will not change practice, nor are they intended to,” said Goldman.

Materiality threshold

This concept is one of the gray areas in auditing. No matter how materiality is defined in the auditing standards, however, there are no bright-line rules. Instead, auditors must rely on their professional judgment to determine what’s material for each company, based on its size, industry, internal controls, financial performance and other factors. Contact us to discuss the appropriate materiality threshold for your company’s financial reporting.

 

Updated standard for limited engagements

At its meeting in late October, the Auditing Standards Board (ASB) voted to finalize changes to its attestation standards. The changes are intended to give accountants more flexibility when performing certain limited assurance procedures.

Most significantly, the revised guidance will allow an accountant to report on the subject matter — which is the information that a financial professional or accountant has to measure or evaluate — without obtaining a written assertion from the party that’s responsible for the subject matter that the subject matter complies with a law or regulation. The guidance can be applied to many types of subject matter, such as a statement about greenhouse gas emissions or the effectiveness of the controls for the security of a system.

The ASB believes it’s necessary to give accountants flexibility when examining or reviewing certain documents if clients can’t appropriately measure or evaluate them. In some cases, the responsible party for the subject matter may not be readily identifiable.

The new rule will replace the current requirement (that all intended users accept responsibility for the sufficiency of the procedures) with a requirement that, before a report is issued, the engaging party acknowledge that the procedures are appropriate for the intended purpose of the engagement. It will also allow general-use reporting and eliminate the requirement that agreed-upon procedures reports be used only by the parties that accepted responsibility for the sufficiency of the procedures.

The revised standard will be effective for agreed-upon procedures reports dated July 15, 2021, or later. Early application is allowed.

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