This year may see a new definition for an old concept: Materiality. The parameters around what constitutes a material disclosure in financial statements will be impacted, and some onlookers say the new meaning will give more discretion to companies, which may lead to less information being provided.
It was 1976 when the Supreme Court decided material would be defined as an omission of factual information (i.e., disclosures). The definition was effectively expanded to cover misrepresentations of fact in a 1988 decision of the Court, and generally applied to both disclosure misstatements and matters of measurement. These definitions were subsequently adopted as part of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, which prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security.
Accountants have traditionally used the definition given in Statement of Financial Accounting Concepts No. 8, Conceptual Framework for Financial Reporting (CON 8), which was released in 2010. CON 8 states, “Information is material if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity.” Concept Statements describe fundamental concepts that are intended to provide guidance on financial accounting practices.
In 2015, the Financial Accounting Standards Board (FASB) proposed to amend CON 8 to eliminate the inconsistency, recognizing that materiality is a legal, rather than an accounting, concept. The inconsistency lies in the fact that one definition uses the word would, while the other uses the word could. Determining whether an omission would have influenced an investor is more difficult to prove than whether such omission could have influenced the investor. However, both are very subjective and not likely to have much impact on the judgments of preparers or auditors.
Since Concept Statements are non-authoritative, the FASB proposed an Accounting Standards Update (ASU), Assessing Whether Disclosures Are Material, to amend the Accounting Standards Codification Topic 235, Notes to Financial Statements, at the same time. The main provisions in the amendment not only refer to materiality as a legal concept, but state specifically that “omitting a disclosure of immaterial information would not be an accounting error.” According to the ASU, “Each Accounting Standards Codification Topic would state that an entity shall provide required disclosures if they are material.”
In January 2016, the SEC’s Investor Advisory Committee voted to request the FASB revise its proposals due to concerns that the new definition of materiality may reduce the amount of information provided to shareholders. However, in February 2016, the AICPA’s Financial Reporting Executive Committee (FinREC) submitted a comment letter to the FASB in favor of its proposals.
This topic is of concern to accountants and businesses alike. While materiality judgments are the responsibility of the reporting entity’s management, it’s important to confer with your trusted accounting advisor to stay informed about what’s required as developments surface through 2016.