The concept of materiality under IFRSs
In 2014, the International Accounting Standards Board (IASB) began discussions on issues arising from the application of the concept of materiality as it pertains to the preparation of financial information under IFRSs. Note that IFRS-compliant financial information can be presented in financial statements and notes thereto, or in other documents. While the concept of materiality has always existed in the accounting environment worldwide, its pre-IFRS application differed greatly from one country or jurisdiction to the next. Today, the concept continues to be affected by local legislation, in the same manner as audit rules and legal definitions of audit.
Historically in Canada, we have often used the concept of materiality to determine the significance of an omission or misstatement in financial statements by setting a “materiality level” based on figures in the financial statements. While this manner of determining materiality is consistent with Canadian Auditing Standards, it does not comply with IFRSs, which indicate that materiality depends on the nature and/or size of the omission or misstatement. Therefore, it does not simply involve a quantitative assessment, but ultimately a qualitative one. As a result, materiality should always be assessed based on the surrounding circumstances and by considering the intended user of the financial information.
In its November 2014 Staff Paper, IASB staff indicated that size alone cannot be a determining factor of materiality under IFRSs. For example, failing to correct an omission simply because of the small “size” of the financial information in question does not meet IFRS requirements (call it “concealing information”). IASB staff also indicated that disclosing too much irrelevant information can also mislead users (call it “muddying the waters”). Therefore, misstated financial information can just as easily be undisclosed (an omission) as it can be disclosed in the wrong amount or in the proper amount but under the wrong presentation format. How then can we strike the right balance between concealing information and muddying the waters?
As an analogy, consider the concept of materiality within the context of building a roadmap:
- It’s clear that a map with too much information, such as the exact address and name of the owner for every location, would be useless to drivers. However, omitting seemingly unimportant information, such as the existence of a little-used alley, could force drivers to take unnecessary detours.
- What about a roadmap that provides all possible information in written text in a book consisting of hundreds of pages with no graphics. Would this really be useful to drivers?
- Would a roadmap provide the same content if it were only intended for pedestrians or mostly for drivers?
The roadmap example helps us understand that preparers of financial information need to consider all misstated financial information (regardless of its size when an amount is involved), assess it based on the surrounding circumstances, and consider potential users and how they could be misled. Therefore, a small error can be considered material under IFRSs. Conversely, there may be cases in theory where a large error is considered immaterial under IFRSs.
- Reconciliation of goodwill: failing to disclose the reconciliation as required under IFRSs would be to conceal a change in goodwill. However, disclosing too much detail about minor changes would muddy the waters. Therefore, it would be best to provide a summary explanation of minor changes, for example by providing the following reconciliation: balance at the beginning of the period + “other changes of $xx” = balance at the end of the period.
- Certain specific information (e.g. the exact number of shares issued) could be immaterial for private enterprises since the primary users, i.e. banks, may not be concerned about it. However, when a company goes public, the exact number of shares is of importance to the stock exchange. Accordingly, a discrepancy in even one share among hundreds of thousands of shares issued would be material to the stock exchange: should the missing share be listed and traded on the stock exchange?
When analyzing errors, preparers of financial information should ask themselves the following five questions. They should also document their answers in the financial information file to support their professional judgment. In some cases, it may be more efficient to correct the misstated financial information rather than document it.
Five relevant questions to consider:
- What decisions could be made based on the misstated information?
- How is the misstated information used in decision-making?
- Could the misstated information influence decisions?
- Are potential decisions based on the misstated information important?
- What can we assume about the intended users of the misstated information?
In 2015, IASB staff plan to issue a proposed standard on applying the concept of materiality when preparing IFRS-compliant financial information.
Jérôme Minier, CPA auditor, CA
Member of the technical working group on IFRS