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The Bruce Column — Materiality and judgement the route to financial reporting clarity

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16 Sep 2015

In the first of a new series of ‘Thinking Allowed’ Deloitte turns its attention to the issue of materiality. Our resident, regular columnist, Robert Bruce reports.

The amount of paper, time and thought which has been taken up in efforts to declutter financial reporting disclosures is possibly, by now, immeasurable. It seems eminently obvious that we need a measure of common-sense, to step back from the mass of minutiae disclosure and concentrate on what is really important. The old propaganda slogan of the Second World War: ‘Is your journey really necessary?’ comes to mind. 

But to get to the point where common-sense and practicality becomes the go-to response is hard. It is not the way that the motivations behind the disclosure of financial reporting traditionally work. And one major part of the decision over what is really necessary is materiality. It seems to be an area on which people find hard to get a grip. 

Part of this is simply the way it has been handled in the past. The assumption behind the wording that the IASB used in IAS 1 became for many people the idea that, frankly, stuff should not be left out. It took an amendment last year which made it clear that even something which was defined as a minimum requirement didn’t have to be included if it was not material. 

But it goes against the cultural grain. All the way through the financial reporting supply chain the culture encourages further bits of immaterial encrustations to become attached. In the first place some of the standards themselves are not very clear about disclosures. Then preparers tend to stick to whatever their procedures were the previous year. And they are acutely aware that the penalties they may suffer for failing to disclose something are much greater than any criticism for leaving too much in. So culturally their procedures are skewed towards more stuff. 

But the problem does not just sit with the preparers.  It is not helpful if their auditors, and then the securities regulators, confront them with disclosure checklists and take a compliance approach to reviewing disclosures.  The users of financial reporting can make it equally hard. The tendency amongst analysts to argue that they would like everything to be available and to leave the sifting to them is rife.  No wonder preparers defend themselves with detail. 

If we are to cut clutter all this needs to stop. And a proper understanding of materiality is a good place to start.  Materiality should be common sense. If a prospective employee, for example, had punched his previous employer on the nose then you would need to know that up front in a cv, and not omitted or be told with hindsight that it is, in fact, disclosed in the equivalent of note 47 in the appendix.  Similarly, an employer does not need a full rundown of every year in the prospective employee’s life.  

Everyone understands materiality in this broad sense. It is about something that is essential to your understanding and to your ability to take a decision. Now everyone across the financial reporting world needs to apply it in the same way. ‘Something’, as Alan Teixeira points out in the first in a new series of thoughts about financial reporting matters, ‘is material to a person if it influences the decisions they make’. And in the financial reporting arena: ‘the question is whether a particular piece of information would influence the decision a person is making, when included in or omitted from a financial report’. 

And the material information needs to be presented properly and not simply included somewhere. It needs to be made clear that a particular piece of information is material and is important. 

All this needs bravery. It needs common sense. But the criteria are relatively simple. People need to stand back and seriously think about the information being presented. Then they can use their judgement and information can be retained or left out. What would then be left would be clear and useful or, as the rules in the UK say these days, fair, balanced and understandable. 

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