Materiality guidance takes shape

The IASB on July 18, 2017, put the finishing touches on the guidance it is drafting to help businesses and other organizations determine the information that is important enough to include in their financial statements.

The board decided to scrap from the final update guidelines about how to assess covenant breaches.

A 7-5 majority agreed to take out the information about covenant breaches, with those in favor of the removal saying keeping the guidance intact could create confusion because of conflicting guidance in auditing standards and with local securities regulations.

The IASB’s forthcoming guidance, expected to be published by the end of the year, will be voluntary. If it included guidelines that do not fit with regulatory rules, the guidance could be useless, a majority of the board said.

“For this to work, we need a group of people to work in partnership,” IASB Vice Chairman Sue Lloyd said. “The document is better served by removing a clear point of tension in the document.”

Several board members offered the opposite view, however.

“The purpose of the Practice Statement is to give guidance to preparers on how to apply materiality,” IASB member Gary Kabureck said. “Giving no guidance on something heatedly discussed and exposed and so on seems to be the wrong answer.”

Based on a proposal the board released in October 2015 via Exposure Draft (ED) No. 2015-8, IFRS Practice Statement: Application of Materiality to Financial Statements, the forthcoming Practice Statement aims to set parameters around what is considered “material.” The Practice Statement is scheduled for publication by the end of the year. The IASB hopes the guidance will help businesses and organizations exercise judgment instead of following checklists to prepare boilerplate-laden financial statements.

The IASB in November 2016, agreed to include specific guidance about how to assess the materiality of information about the existence and the terms of a covenant and covenant breaches. The board at the time said businesses should consider the consequences of a covenant breach on the entity’s financial position, financial performance and cash flows, and the likelihood of a breach occurring.

The board at the time agreed that materiality judgments about the information about covenants are specifically influenced by the consequences of a covenant breach occurring as well as the likelihood of one happening. In other words, if the consequences of a breach would significantly affect a business’s financial health, but the likelihood of one happening is remote, the covenant is not material.

Some external reviewers questioned whether this late addition to the draft statement would introduce conflict with SEC guidance on assessing materiality. The SEC Staff Accounting Bulletins, Topic 1: Financial Statements, M. Materiality, includes among the considerations that may render material a quantitatively small misstatement, the fact that the misstatement affects the entity’s compliance with loan covenants or other contractual requirements.

“If this statement is in conflict with what regulators think and what auditors think, I don’t think this Practice Statement is the right place,” IASB member Martin Edelmann said.

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