The concept of “materiality” may provide the answer
It’s easy for companies to get bogged down by “disclosure overload.” The concept of materiality can help owners and managers identify what’s most important to a company’s financial well-being, warranting additional disclosures in the financial statements. Unfortunately, the Financial Accounting Standards Board (FASB) doesn’t currently define what information should be considered “material” when an organization prepares its financial statements.
Instead, materiality is generally a legal concept, often defined through court decisions. The U.S. Supreme Court’s description of materiality is a “substantial likelihood” that omitting the information would be viewed by a reasonable investor or creditor as having “significantly altered” the total information available to make a decision. Will the FASB accept this definition, or will it craft another one?
Answering the need for clarity
The FASB has decided that the concept of materiality needs clarity. So, in September, the board released two related proposals to guide businesses on when to include information in a footnote disclosure and when to omit it. Under the proposals, businesses must assess whether investors will find the information useful and whether the information fits the legal concept of materiality before including it in a footnote.
“These proposals are intended to clarify materiality, which will help organizations improve the effectiveness of their disclosures by omitting immaterial information, and focus communication with users on the material, relevant items,” commented FASB Chairman Russell Golden.
Proposed Amendments to Statement of Financial Accounting Concepts No. 2015-300, Conceptual Framework for Financial Reporting Chapter 3: Qualitative Characteristics of Useful Financial Information, offers changes to the FASB’s Conceptual Framework, the set of guidelines the FASB uses to write U.S. Generally Accepted Accounting Principles.
Proposed Accounting Standards Update No. 2015-310, Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material, offers a process businesses can follow to ensure that they include only relevant information in their footnotes when complying with an accounting standard.
The FASB proposals call for the concept of materiality to be the basis by which businesses decide when to include information in their footnotes. In addition, if a business or group doesn’t provide a disclosure because its management has concluded that the information isn’t material, the omission would not be considered an accounting error.
Earlier this year, the FASB said it would rely on the Supreme Court’s description of materiality. By July, however, some FASB members expressed concerns that the Court’s definition of materiality could evolve over the years — and potentially morph into something that’s overly prescriptive or otherwise undesirable from a financial reporting perspective. So, the FASB is considering omitting any specific references to the Court’s definition.
Simplifying without compromising quality
Materiality is one of the gray areas in financial reporting. The FASB’s proposed changes to the materiality framework are designed to help facilitate management’s decision-making process and eliminate unhelpful, boilerplate information in the footnotes that makes it harder for investors to get at important facts. The ultimate goal is to make existing disclosures more effective and concise. Comments on the FASB’s proposals to clarify the concept of materiality are due by December 8.
Sidebar: Global variances
The guidance on materiality under existing U.S. Generally Accepted Accounting Principles (GAAP) essentially matches the International Accounting Standards Board’s (IASB’s) definition. Under this definition, materiality is “an entity-specific aspect of relevance based on the nature or magnitude (or both) of the items to which the information relates in the context of an individual entity’s financial report.” Under both U.S. and international guidance, there’s no specific quantitative threshold for materiality.
If the Financial Accounting Standards Board (FASB) adopts its proposed changes, the new definition of materiality under GAAP could differ somewhat from the IASB’s definition. The FASB acknowledges that, while it is preferable that the conceptual frameworks be converged, it’s not possible because the IASB’s definition isn’t consistent with the legal concept of materiality in the United States.