Disclosure Initiative: Principles of Disclosure — Comment period for the Discussion Paper — Agenda paper 11

The Staff is currently in the process of balloting the Principles of Disclosure Discussion Paper. The purpose of this session was to ask the Board whether they agree with the Staff’s proposal of having a comment period of 180 days for the Discussion Paper due to its length and other reasons.

Discussion

The IASB voted unanimously in favour of the Staff recommendation.

The Staff also revised the expected publication date of the Discussion Paper from mid-December 2016 to February 2017 in order to provide the Board with more time to focus on matters relating to the draft insurance standard.

Disclosure Initiative: Materiality — Cover paper — Agenda paper 11A

The Board published the exposure draft IFRS Practice Statement: Application of Materiality to Financial Statements in October 2015 (the ‘ED’) and the Staff provided a high level summary of the feedback received to the Board in its April 2016 meeting. The purpose of this session was to discuss the following issues raised by respondents to the ED and to ask the Board what changes, if any, should be made to the final Practice Statement (‘PS’) in light of the comments received:

• Audience, focus and definition - Agenda paper 11B
• Primary users’ needs and expectations - Agenda paper 11C
• The Materiality Process - Agenda paper 11D
• Primary financial statements versus notes and aggregation / disaggregation of information- Agenda paper 11E
• Accounting policy disclosures - Agenda paper 11F
• Comparative versus corresponding approach and conflicts with local regulations - Agenda paper 11G
• Interim reporting - Agenda paper 11H
• Publicly available information - Agenda paper 11I

Disclosure Initiative: Materiality — Audience, focus and definition — Agenda paper 11B

Guidance proposed in the ED and feedback received

Audience: The ED is addressed only to the preparers of financial statements. Most respondents suggested broadening the audience of the PS to include other stakeholders such as auditors, regulators and enforcers because their policies and procedures affect the materiality judgements of preparers. Furthermore, a respondent proposed replacing ‘management’ with ‘entity’ throughout the PS as the term ‘management’ is not defined in IFRS Standards.

Focus: The ED makes references to instances in which the concept of materiality is applied other than in the preparation of financial statements, e.g. materiality considerations for legal, regulatory, and audit purposes. Some respondents suggested that such references should be deleted as they are covered by other rules and regulations and are out of scope of the PS; yet others believed that preparers of financial statements and their auditors apply the concept of materiality similarly: both are focused on what information could influence the decisions of primary users.

Definition: The ED includes the definition of materiality as it is appears in the Conceptual Framework. The ED also refers to IAS 1 on how the phrase ‘could influence decisions that users make’ as used in the definition of materiality should be interpreted. Some respondents were concerned that the phrase ‘could influence’ sets the materiality threshold at a low level and that the definition is inconsistent with that proposed to be adopted by the FASB.

Staff analysis and recommendation

The Staff recommended the following:

Audience:

1. Retaining the proposal in the ED to address the PS only to those involved in the preparation of financial statements, but acknowledging that the PS may benefit other parties involved in the financial reporting process. This would be consistent with the Board’s stated objective for the ED which is to provide guidance to assist entities in applying the concept of materiality in preparing financial statements, as well as to help other parties understand the application of materiality in the preparation of the financial statements.
2. Replacing the term ‘management’ with ‘entity’ throughout the final PS. This would be consistent with the terminology used in IFRS Standards and would avoid any confusion as to which level of management the PS is directed at.

Focus:

1. Limiting the PS’s reference to the concept of materiality to the preparation of financial statements only. This is because other applications of the materiality concept are beyond the scope of the PS and might cause confusion.

Definition:

1. Including in the PS the interpretation of materiality in IAS 1.7, i.e. it should take into account how a user ‘could reasonably be expected to be influenced’. The Staff believes that this would address the concern of the low materiality threshold in that almost anything ‘could’ influence a decision.
2. That no change be made to the existing definition of materiality within this project as that was not part of the scope of this project.

Discussion

The Board approved all of the Staff’s recommendations.

As regards the audience of the ED, some Board members pointed out that the ED should emphasise the context in which the concept of materiality should be applied (i.e. from the perspective of preparing financial statements) rather than making the preparers of financial statements the sole addressee of the ED, as the latter appeared to exclude other stakeholders. The Board believed that this fine-tuning would help align the materiality assessment of management with that of auditors.

As regards the focus of the ED, one Board member asked whether the financial information included in the management commentary should be subject to the materiality concept in the PS as he believed that information contained in the management commentary should have the same quality as those included in the financial statements. However, other Board members and the Staff disagreed as they believed that the management commentary is outside the scope of IFRS and was thus not covered by the PS. Furthermore, there might be other regulations governing the disclosures in the management commentary. In the end, the Staff was asked to consider whether they should address this issue in a separate paper.

Disclosure Initiative: Materiality — Primary users’ needs and expectations — Agenda paper 11C

This paper proposed various changes to wordings as regards users’ needs and expectations in order to remove internal inconsistencies in the PS and to align the wording with that proposed in the Conceptual Framework ED.

Staff analysis and recommendation

The Staff recommended the following:

1. Emphasising in the PS that the ‘primary users’ of the entity’s financial statements include potential investors, lenders and other creditors. This would respond to the concerns raised that an entity might inappropriately focus only on its existing users’ information needs.
2. Removing any reference to the ‘special needs’ of primary users and references to ‘subsets’ or ‘classes’ of primary users from the PS. This is because identifying users’ special needs is inconsistent with the Conceptual Framework definition of general purpose financial statements, which focuses on the ‘common information needs’ of users. Furthermore, the Conceptual Framework focuses on the primary users group instead of emphasising the existence of ‘subsets’ or classes’ of primary users.
3. Emphasising what is meant by the concept of meeting ‘the maximum amount of common information needs’ of an entity’s primary users. This would entail identifying the information needs that are common within each category of primary users, the sum of which would meet the PS’s requirement. This would prevent the entity from identifying only those needs that are simultaneously common to all categories of an entity’s primary users (as this might inappropriately exclude information that is relevant only to a particular category of users), and an entity would not need to consider information needs that address unique requests.

Discussion

The Board approved all of the Staff’s recommendations.

Some Board members were uncertain as to how the term ‘common’ should be interpreted – is it common as in ‘usual’, or common as in ‘shared characteristics’? A Board member was also concerned that removing the references to ‘classes’ and ‘subsets’ might make it harder for users to understand the concept of ‘common’ that the Staff has expressed in the agenda paper. Nevertheless, in general the Board was in favour of the Staff’s intention and direction with the concept but asked that the Staff redraft the notion to make it more easily understandable.

Disclosure Initiative: Materiality — The Materiality Process — Agenda paper 11D

Many respondents requested that the PS include a decision-tree that describes the thought-process in applying judgement to materiality decisions (the ‘Materiality Process’).

Staff analysis and recommendation

The Staff recommended including the Materiality Process in the PS and recommended a 4-step Materiality Process as follows:

1. Step 1—identify potentially material information.
2. Step 2—assess whether information identified in Step 1 is material by considering quantitative, entity-specific qualitative and external qualitative factors in its assessment.
3. Step 3—organise the information identified in Step 2 in the draft financial statements in a way that communicates the information effectively and efficiently to the users of the financial statements.
4. Step 4—review the draft financial statements as a whole to determine whether all material information has been identified, including consideration of materiality from an aggregated perspective.

Discussion

The Board approved the Staff recommendation.

The Board agreed with the steps included in the Materiality Process; however, some members suggested re-characterising ‘The Materiality Process’ to a materiality process to highlight the fact that this was simply a reference tool and acknowledging explicitly in the PS that other processes (i.e. the order of performing the above steps) might be appropriate. A Board member also asked the Staff to state explicitly in the PS that information would be material as long as it met either the quantitative assessment or the qualitative assessment. The Board further suggested that the discussion of whether a related party transaction was material as was included in the ED should be illustrated in the form of an example rather than being a separate section in the PS. This was because the latter put undue focus on related party transactions which might be misconstrued as being automatically qualitatively material. Furthermore, this would contradict with the overriding principle of the PS that an entity should apply the same materiality assessment to all transactions. The Staff were also asked to consider including other examples to illustrate the application of qualitative factors in a particular context to accompany the example of related party transactions.

Disclosure Initiative: Materiality — Primary financial statements versus notes and aggregation / disaggregation of information — Agenda paper 11E

Guidance proposed in the ED and feedback received

The proposed wording in paragraph 30 of the ED raised many concerns on whether different levels of materiality should be applied for the primary financial statements versus the notes. Furthermore, some respondents also requested a decision tree to illustrate the process that should be followed when considering an item for aggregation and disaggregation.

Staff analysis and recommendation

The Staff recommended the following:

1. Stating that a single assessment of materiality is applied to all information included in the financial statements. Materiality is not assessed differently for information that is presented in the primary financial statements from information that is disclosed in the notes.
2. Explaining that the decision about where material information should be disclosed (i.e. primary financial statements versus notes) is a question of how to organise the information in a way that communicates the information effectively and efficiently. Step 3 of the proposed ‘Materiality Process’ (see Agenda Paper 11D) provides further guidance and the Principles of Disclosure project will consider this issue further.
3. In determining the level of detail in which an entity needs to disclose information in its financial statements, the assessment should be made from the perspective of how far to disaggregate the entity’s information (as opposed to how much information should be aggregated). This approach is better aligned with how primary users tend to analyse an entity’s financial statements. Nevertheless, the PS would acknowledge that either an aggregation or a disaggregation approach is acceptable and both approaches should give the same results if the same approach to assessing materiality is used.

Discussion

No vote was taken on this issue.

The Staff was asked to redevelop the paper for future discussion. The gist of the discussion was that many Board members struggled with determining where to place material information in the financial statements, and how much information should be disclosed in the notes. One Board member raised the point that many of the note disclosures might not be material on an individual basis, and asked the Staff how this could be reconciled to the concept of applying the same materiality assessment to the financial statements as a whole. The Staff were asked to clarify the functions that the notes served in a set of financial statements (e.g. disclosing judgements, assumptions, events post reporting date, etc.) and to present the discussion in the context of the notes providing more information on items already presented on the primary financial statements, which was one of the functions served by the notes, in order to focus future Board discussions

Disclosure Initiative: Materiality — Accounting policy disclosures — Agenda paper 11F

Guidance proposed in the ED and feedback received

The ED does not contain a specific section on the application of materiality to accounting policies. Various respondents highlighted a number of practical issues in the absence of such guidance.

Staff analysis

The Staff assessed whether additional guidance should be provided in the PS based on whether accounting policies are capable of influencing primary users’ decisions.

View A: No. Accounting policies only provide the context for understanding the information included in the financial statements. As they are not capable of influencing primary users’ decisions, the concept of materiality does not apply.  Furthermore, the Principles of Disclosure Discussion Paper (‘POD DP’) states that significant accounting policies, which are those that are necessary for an understanding of the financial statements, should be disclosed and includes guidance on what information should be disclosed. Accordingly, the PS should not include further guidance but should refer to the POD DP.

View B: Yes. The information about accounting policies is capable of influencing the primary users’ decisions and so the concept of materiality applies. The Staff believes that assessing whether an accounting policy relating to material information is itself material involves assessing whether that accounting policy is a ‘straightforward’ accounting policy. An accounting policy is straightforward if it is applied without having to use significant judgement or having to make a choice in accordance with an option permitted by an IFRS Standard.

View A (i.e. the POD DP) differs from view B in the perception of primary users’ knowledge of IFRS Standards. According to the POD DP, straightforward accounting would still need to be disclosed for users to understand the information in the financial statements if they relate to material items.

The Staff believed that an accounting policy is capable of influencing primary users’ decisions when: (a) the accounting policy is related to material information; and (b) an entity makes an accounting policy choice, or uses significant judgement to apply or develop the accounting policy. The Staff further believed that users are expected to have a reasonable knowledge of business and economic activities and thus they are expected to be able to understand an entity’s financial statements without the disclosure of straightforward accounting policies.

Staff recommendation

The Staff recommended view B for the reasons set out above.

Discussion

This paper was not discussed and no vote was taken at the request of the Chairman.

The Chairman believed that the Board should not reopen discussions on this topic when a conclusion had already been reached in the POD DP which was currently being balloted. Since the POD DP would provide guidance on the disclosure of accounting policies, no discussion of this matter would be carried out in the Materiality project.

Disclosure Initiative: Materiality — Comparative versus corresponding approach and conflicts with local regulations — Agenda paper 11G

Guidance proposed in the ED and feedback received

The Exposure Draft provides some guidance on how to apply materiality to prior period information; however, it does not distinguish between the ‘comparative’ approach and ‘corresponding’ approach to prior period information, which imposes different auditor responsibilities. Under the corresponding approach, the auditor’s opinion on the financial statements refers to the current period only; in contrast, under the comparative approach, the auditor’s opinion refers to each period for which financial statements are presented. In the absence of a clear basis to disclosing prior period information, some respondents questioned the extent of prior year information that should be provided when that information is no longer material in the current period, or when information that was not disclosed in the prior period is material to an understanding of the current year financial statements.  

Furthermore, some respondents were concerned that the disclosure of immaterial information (assessed in terms of the PS) required by local regulations would not be in compliance with the requirements of the PS.

Staff analysis and recommendation

The Staff recommended the following:

1. Acknowledging in the PS the existence of the ‘corresponding’ and ‘comparative’ approaches to previous period information as defined in ISAs.
2. Focusing on the ‘corresponding’ approach in the PS, on grounds that this approach is consistent with IAS 1.38 which states that an entity should include prior period information if it is relevant to understanding the current period’s financial statements. This would mean that prior period information which is necessary to the understanding of the current period financial statements should be included even if that information was not disclosed in prior periods; whereas prior period information disclosed in the past should not be automatically included in the current period.
3. Clarifying that the PS is not a Standard and its application is not required in order to state compliance with IFRS Standards, and that the provision of additional information to meet local regulatory requirements is not prohibited by IFRS Standards even if that information is not material for IFRS Standards.

Discussion

No vote was taken on this issue. The Staff was asked to redevelop the paper for future discussion.

One Board member strongly disagreed with the Staff analysis on the grounds that the issue of ‘corresponding’ v. ‘comparative’ was a significant issue in practice and these terms were not addressed in IFRS. The Board member pointed out that IAS 1 very clearly used the word ‘comparative’ and if the PS were to advocate the use of the ‘corresponding’ approach, not only would this be contrary to the term used in IAS 1, the Board would also be including guidance/interpretation in a non-authoritative PS in relation to terms used in authoritative IFRS literature. Moreover, ‘corresponding’ prior period information is not an existing concept in IFRS. The Board member pointed out further that no consultation was made on the ‘comparative’ v. ‘corresponding’ issue and it would be wrong of the Board to discuss these approaches and draw a conclusion in the PS.

The Staff was asked to explore ways to address disclosures regarding prior period information without reference to these two terms and bring it back to the Board for further discussion.

With regard to the interaction of local regulations with IFRS, the Board commented that the PS should emphasise what was the objective of the PS rather than what was not the objective of the PS, as the latter would create a precedent and an expectation that the Board would insert a list of what was not the objective in other standards when things were unclear. Another Board member asked the Staff to state explicitly in the ED that local regulations could not override the materiality assessment of IFRS.

Disclosure Initiative: Materiality — Interim reporting — Agenda paper 11H

Given the short section on interim reporting provided in the ED, the respondents raised various questions as regards how materiality should be applied to interim reporting.

Staff analysis and recommendation

In response to the questions raised by the respondents, the Staff recommended the following:

1. Emphasising that an entity should apply the Materiality Process (see agenda paper 11D) in the application of materiality to the interim financial reports. The Staff believes that the Materiality Process does not change when applied to the interim financial statement.
2. Specifying that an entity needs to apply the Materiality Process taking into account that the context and purpose of an interim financial report are different from those of an annual report, i.e.:
   1. information in the interim financial report is assessed in relation to the interim period financial data, not forecast annual data;
   2. in the case of quarterly reporting, the Materiality Process is applied to both the current interim period data and the cumulative period-to-date data;
   3. information that is material to the interim financial report, but not material to the annual financial statements, need be disclosed only in the interim financial report;
   4. information that is not material to the interim financial report but is expected to be material to the annual financial statements need not be disclosed in the interim financial reports; and
   5. information that is material to the interim period, but was already presented and disclosed in the latest annual financial statements does not need to be reproduced in the interim financial report, unless something new occurs or an update is needed.

Discussion

The Board approved all the Staff’s recommendations subject to editorial changes.

Disclosure Initiative: Materiality — Publicly available information — Agenda paper 11I

Guidance proposed in the ED and feedback received

Some respondents found the existing wording in paragraphs 57 and 58 of the ED unclear as to whether publicly available information should affect the materiality assessment.

Staff analysis and recommendation

The Staff recommended clarifying that:

1. An entity needs to assess whether information is material to the financial statements regardless of whether it has already been made public. This is because by definition, material information is information that could reasonably be expected to influence primary users in making economic decisions; therefore, information should not be assessed as not material because it has already ‘had the chance’ to influence primary users’ decisions.
2. Having publicly available information does not relieve the entity of the obligation to disclose material information.

Discussion

The Board approved the Staff’s recommendations.