The European Securities and Markets Authority received a wide
range of comments in response to its consultation paper on materiality in
financial reporting. The majority of
commenters said that the concept of materiality is generally well understood,
but many expressed the view that there is diversity in application. However,
users of financial statements were more divided on the issue, noted ESMA, with
over half of those expressing the view that the materiality concept was not
clearly and consistently understood.
Diversity in application of materiality was attributed to the fact
that significant judgment is necessarily involved and that the concept is
applied at the entity-specific level. Many commenters pointed out that
differing judgments on materiality do not necessarily represent a lack of
consistency, with more than one conclusion being valid. A number of commenters
attributed differences arising in either understanding or application to the
separate perspectives of the various stakeholder groups, such as preparers,
auditors, regulators and users.
Deloitte Touche Tohmatsu commented that the application of a
materiality standard necessarily involves the application of professional
judgment. There are circumstances when more
than one valid conclusion can be reached based on the exercise of professional
judgment, said Deloitte, which does not equate to a lack of consistency in the
application of materiality.
In its comment letter, KPMG noted that materiality is a
fundamental and pervasive concept underlying the preparation, audit and use of
financial statements. Thus, said KPMG, it is important that the definition of
materiality is the same for preparers and auditors, and that it is understood
by users.
Commenters said that
guidance on materiality could be useful and singled out the IASB as the proper
body to provide such guidance. KPMG believes that the necessary consistency can
be maintained only if the IASB remains the sole source of both the definition
of materiality and guidance on its application for the preparation of IFRS
financial statements. KPMG urged the International Auditing and Assurance
Standards Board (IAASB) to align fully its guidance on materiality for auditors
with the IASB definition of and guidance on materiality.
Deloitte favors a single set of high-quality financial reporting
standards applied without regional variation. In order to get there, Deloitte
believes that the fundamental characteristics
of financial reporting, including
the concept of materiality, must be set by global independent standard setters
like the IASB and IAASB and any guidance on materiality must come from these
global standard setters and not national standard setters.
Echoing these comments, Ernst & Young said that, since
guidance ensuring the consistent application of materiality is a global issue,
the IASB is the proper body to provide such guidance. Further, given the
relevance of materiality to the audits of financial statements, guidance should
be done in consultation with the IAASB.
In
its comment letter, PricewaterhouseCoopers said that a national or regional
regulator is not the appropriate body to issue guidance on the concept of
materiality given that the accounting and auditing standards to which such
guidance would apply have global application. Rather, in the event consensus
for additional guidance emerges from further dialogue, such guidance should be
developed by the IASB in concert with the IAASB. PwC is concerned that adopting
a regional or national approach to guidance applicable to financial statements
prepared in accordance with IFRS could result in less, rather than more,
cross-border consistent application.
PwC
said that users and regulators might benefit from additional dialogue regarding
the qualitative aspects of materiality and its application to increasingly
subjective and imprecise information inherent in current financial reporting.
The IASB’s development of a disclosure framework would serve a valuable role in
providing context to the judgments that need to be made by management and
auditors with respect to the materiality and relevance of the disclosures in
the context of the fair presentation of a firm’s financial statements.
The failure to properly apply the concept of materiality to note
disclosures was a common theme of the responses, said ESMA, with commenters
noting the reluctance to exercise judgment to exclude information from the
financial report. When immaterial items are included in the notes, useful and
material information could be obscured, making the financial report less
relevant.
With regard to notes, PwC said that generally
the same materiality considerations should apply as for primary financial
statement items, that being: what information is relevant for the users of the
financial statements. As this
information is often difficult to quantify, qualitative aspects are of
importance.
KPMG
said that the materiality
of a disclosure item should not be determined solely by the materiality of the
related financial statement line item. The materiality of a disclosure should
be judged by considering the objective of the disclosure and whether the
omissions or misstatements of items could, individually or collectively, influence
the economic decisions that users make on the basis of the financial
statements. This would involve an evaluation of the company’s specific facts
and circumstances including the consideration of qualitative factors.
Introducing a rule requiring
disclosure of additional information in the notes because the related line item
in the financial statements is material could reinforce a checklist mentality,
cautioned KPMG. It also would risk
impairing the understandability of the disclosures and of the financial
statements themselves if such additional information is voluminous.
In the Consultation Paper, ESMA noted that materiality
has qualitative as well as quantitative aspects. The vast majority of
commenters believe that materiality must be based on both quantitative and
qualitative characteristics. They highlighted the
fact that materiality is not a simple quantitative figure and that the
qualitative aspects must take account of the specific facts and circumstances
surrounding each item. This determination requires professional judgment based
on all relevant information. Because of
the range of facts, circumstances and requirements that must be considered,
many commenters contended that different materiality thresholds are applied all
the time depending on the item under discussion.
E&Y noted that one quantitative metric should
not ultimately determine all materiality judgments. The application of the
concept of materiality is not just a mathematical exercise, said E&Y,
instead it involves a significant amount of judgment considering the relevant
facts and circumstances.
In its comment letter, BDO said it is essential
that materiality is determined from both a quantitative and a qualitative
perspective, together with a consideration of the financial statements as a
whole. Indeed, continued BDO, qualitative characteristics of materiality are
likely to be of greater importance when considering disclosures to be included
in financial statements since they encompass both numerical and narrative
aspects. For example, while an item included in financial statements might,
from a numerical perspective, be relatively small at a reporting date, its
potential future changes in value might be highly material.
Grant
Thornton commented that materiality assessments should take into account both quantitative and
qualitative factors. Quantitative thresholds can serve a purpose in
establishing a starting point or benchmark, noted GT, but a rigidly applied
quantitative threshold is unlikely to work in all circumstances.
Most commenters indicated that they were not in favor of including
an accounting policy disclosing materiality judgments in the financial
statements. They feared that there was a
significant risk that such disclosures would become boilerplate, and therefore,
would not provide relevant entity-specific information to users.
E&Y was concerned that a meaningful accounting policy on the
materiality judgments made in preparing the financial statements may turn out
to be quite lengthy since it would be difficult to draw the line for items to
be included. In addition, there is a risk that such a policy may add to the
expectation gap.
BDO did not believe that it is appropriate for materiality
judgments by preparers to be disclosed as an accounting policy. BDO feared
that, since views about materiality vary, there is a risk that users of
financial statements on which an auditor has given an unqualified opinion would
assume a higher degree of agreement by an auditor on a stated policy than might
be the case.
Grant
Thornton was not convinced that such a disclosure is feasible or would provide
useful information. In GT’s view, the disclosures required by IAS 1 on key
judgments and estimates are sufficient for users to understand those judgments
management have made that are most likely to have an effect on the financial
statements.