Several major new IFRS standards have become effective recently or will do so soon and, as is the case for every new standard, these will mean changes and new requirements not only for accounting treatments but also for disclosures. Altogether, there will undoubtedly be a lot of additional work for both financial statement preparers and their auditors.
Therefore, it is no surprise that—now more than ever—the central area of interest regarding these new IFRS standards is materiality. Indeed, materiality is usually responsible for the disputes that emerge between financial statement preparers, auditors, and regulators. In this article, we'll aim to shed some light on materiality and the rules surrounding it.
The rules of materiality and how they're developing
Materiality is one of the key variables of the IASB's Disclosure Initiative project, whose aim is to improve disclosures in order to provide better understanding for the primary users of financial statements. In other words, the project wants to provide enough relevant—and not too much irrelevant—information, and to communicate it effectively.
Recently, two new milestones have been hit in the field of materiality.
Firstly there is the IFRS Practice Statement 2: Making Materiality Judgments. This recently issued document contains non-mandatory guidance on how to apply materiality when preparing financial statements. It explains several general characteristics, such as how IFRS requirements need only be applied if their effect is material to the complete set of financial statements, or how IFRS disclosure requirements do not apply for immaterial items even if the IFRS contains a list of "minimum requirements."
Does that mean that immaterial errors can be made intentionally to achieve a particular presentation of an entity's financial position, financial performance, or cash flows? Of course not! Such financial statements would not be compliant with IFRS.
The practice statement also stipulates that it's not possible for the financial statements to provide all the information that primary users need. Rather, their main focus is to assist those who are making capital allocation decisions. Most importantly, the practice statement has a four-step materiality process that helps preparers make materiality judgments to achieve the right amount of relevant information in their financial statements.
"Applying materiality in preparing financial statements". KPMG IFRG Limited internal source. 2018. Retrieved 2019-02-13.
Secondly, a new amendment to IAS 1 and IAS 8 was issued late in 2018, revisiting the definition of materiality: in addition to "omitting or misstating" information, "obscuring" information is now also named directly in the definition as an obstacle to materiality. In other words, the effect of omitting information in a financial statement may be the same as presenting information in a way that is hard to identify or understand. These amendments are effective from 1 January 2020, though they have not yet been endorsed by the EU.
Do you play by the rules?
The most important element in the preparation of IFRS financial statements is judgment. If properly reasonable judgments are applied, then IFRS requirements and financial statement disclosures can be reduced to a reasonable amount. However, the entity always needs to consider whether a (non)provisional piece of information, even if not specified by an IFRS, will be properly understood by the primary users of the financial statements. Similarly, materiality considerations need to take into account both quantitative and qualitative aspects of a piece of information and its relevance to the primary users of the financial statements. The key, ultimately, is to provide an appropriate amount of information in the financial statements and arrange it in an understandable way.
Additionally, bear in mind that errors, even immaterial ones, made for the purpose of achieving a pre-determined result are prohibited. So, do you play by the rules?
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.