Financial statement disclosures: A closer look at materiality
The concept of “materiality” helps management identify what’s important enough to a company’s financial well-being to warrant additional disclosures in the financial statements. Unfortunately, the Financial Accounting Standards Board (FASB) doesn’t currently define what information should be considered “material” under Generally Accepted Accounting Principles.
Investors don’t generally view materiality in terms of rule-of-thumb percentages. Instead, they see it as a qualitative, legal concept. 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.
Proposals attempt clarity
In late 2015, the FASB 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 would be required to assess whether investors will find the information useful and whether the information fits the legal concept of materiality.
Many businesses are concerned that the Supreme Court’s definition of materiality could evolve over time — 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.
To further complicate matters, if the FASB adopts these proposals, its definition of materiality could differ somewhat from the definition set forth by the International Accounting Standards Board.
Materiality is a gray area
The proposed changes to the materiality framework are designed to help facilitate management’s decision-making process. They aim to eliminate unhelpful, boilerplate information in the footnotes that makes it harder for investors to get at important facts.
During a March 2016 meeting, the FASB reviewed comments letters on its proposals. Now the project is back in the re-deliberation phase.
Materiality judgements have always been implicit in the preparation of footnote disclosures. However, the proliferation of disclosure requirements in accounting standards in recent years, along with heightened expectations for documenting the rationale for any excluded disclosures, has increased the volume and cost of disclosures with a perceived commensurate benefit in their effectiveness. The proposed amendments are intended to clarify that entities can apply judgement to eliminate immaterial information.
Contact Moore Stephens Doeren Mayhew for the latest information about this fundamental financial reporting concept.
James L. Noteman, CPA
With more than 30 years of experience in public accounting, Jim Noteman is relied on by a wide range of clients for his audit and advisory expertise. Since joining Moore Stephens Doeren Mayhew in 1999, Jim’s focus has been on assisting clients in the manufacturing, distribution and retail industry sectors, as well as multi-national corporations. Contact Jim at email@example.com or (248) 244-3250.