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

• (a) Errors - Agenda paper 11A
• (b) Covenants - Agenda paper 11B
• (c) Stewardship - Agenda paper 11C
• (d) Recognition and measurement - Agenda paper 11D
• (e) Entities applying the IFRS for SMEs Standard - Agenda paper 11E
• (f) Status and form of the guidance - Agenda paper 11F

Appendix A provided some background information on the Materiality project and Appendix B provided a summary of the tentative decisions that the Board has made to date.

Next steps

In the December 2016 Board meeting, the Staff intends to ask the Board to re-deliberate the application of materiality to prior period information. The Staff intends to complete all the technical deliberations at that meeting.

Disclosure Initiative: Materiality – Errors - Agenda paper 11A

Background

Some respondents asked for more practical guidance on assessing when errors are material to the financial statements. Specifically, several respondents asked for guidance on cases when the cumulative effect of previously immaterial errors becomes material in the current period - they asked whether an entity should correct those errors by restating prior period information. Some respondents also noted that the ED is inconsistent with IAS 8.41 where the former states that errors made intentionally to achieve a particular result are always material.

Staff analysis and recommendation

The Staff recommended the following:

1. Suggesting in the PS that entities apply the Materiality Process (see Agenda Paper 11D of the October 2016 meeting) in order to assess whether an error is material.
2. Clarifying that the assessment of the materiality of a cumulative error should be performed on the basis of the conditions existing at the time the financial statements for the current period are authorised for issue, and that the PS should not provide any guidance on how to correct a material cumulative error
3. • (a) Removing the wording implying that if management intentionally misstates information to achieve a particular result, such errors are always material.
   • (b) Including a reminder that IAS 8.41 requires an entity to correct all errors made intentionally to achieve a particular presentation, regardless of their materiality.
   • (c) (c) Explaining that an error made intentionally to achieve a particular presentation was one that led an entity to fail to comply with the neutrality of the presentation of its financial position, financial performance and cash flows.

Discussion

The Board approved recommendations 1, 2 and 3(a), but rejected 3(b) and 3(c).

In relation to recommendation 1 which also applied more broadly to the rest of the discussion, one Board member cautioned against adding more guidance in the PS as that might run the risk of creating more problems. She reasoned that given materiality was itself a sensitive issue, it was made even more so when applying materiality to error corrections. Accordingly, it was not surprising that respondents wanted more guidance, but there might be ways to address these requests (or other places to add guidance) other than by adding more material in the PS. Another Board member supported her in that the Board should focus on the scope of the project, and not to expand the PS to include interpretation or rationales for concepts already contained in extant Standards based on seemingly good requests from respondents.

In relation to recommendation 2, there was significant discussion on whether the PS should include guidance on how to correct a material cumulative error, i.e. should the error correction be reflected wholly in the current year or should prior periods be restated. Those who supported including more guidance noted that this was a real practical issue and remaining silent on this issue would not be helpful. They believed that there was a principle which could be made clear in the PS, in that prior year figures should be restated otherwise the current year figures would be materially misstated. In response, the Staff said that how to correct an error was outside the scope of the PS. The Staff also asked whether the PS was the best place to put this guidance given its non-authoritative status. A few other Board members agreed with the Staff and emphasised that the scope of the PS was limited to the application of materiality on presentation and disclosure. If the PS included guidance on how to correct an error then it would open the door for inclusion of other seemingly related topics. They also added that the principle of how to correct a material cumulative error should be properly consulted and that consultation should not hold up the publication of the PS.

In relation to recommendation 3, the Board expressed significant discomfort regarding the proposal in 3(c) and its inclusion in the PS for the following reasons:

• Including such a statement went beyond the norm of standard setting, in that none of the other Standards referred to the qualitative characteristics of useful financial information in case of non-compliance with that particular Standard.
• Including such a statement gave the appearance of softening the seriousness of intentionally misstating the financial statements, whether material or not, as it might be read as relegating an intentional error to the ranks of merely not meeting a qualitative characteristic of useful financial information.
• One member also noted that there was a circular interaction between neutrality and materiality. In his view, the determination of whether financial information was neutral would be based, to a certain extent, on whether the error was material. Yet the proposed statement said that any intention error would not result in neutral information, thus implying that the error was material even though on a separate assessment it would be considered to be immaterial. The Staff responded that they regarded the intention to mislead as a subset of neutrality. However, this was different from the deliberate use of practical expedients as the latter did not carry with it the intention to misstate financial information in order to achieve a particular presentation.

On that last point, a number of Board members said it would be crucial for the PS to distinguish between (i) practical expedients explicitly labelled as such in various standards, e.g. IFRS 15 and IFRS 16, (ii) other simplifications used when accounting for transactions e.g. using the monthly average exchange rate to translate foreign currency transactions, and (iii) deliberate attempts to misstate financial statements to mislead users. These Board members commented that the materiality concept should be applied to each of them separately due to their vastly different nature.

Disclosure Initiative: Materiality – Covenants - Agenda paper 11B

Background

Respondents asked for more guidance on what are the circumstances that would make information about a covenant or a breach of covenants material.

Staff analysis and recommendation

The Staff recommended that the PS include specific guidance on:

1. how to assess the materiality of information about the existence and the terms of a covenant, or a breach of covenant; and
2. how the existence of a covenant affects the materiality assessment of the factors triggering the covenant.

In making the above assessments, the Staff recommended that an entity consider:

• (a) the materiality of the consequences of the covenant breach on the entity’s financial position, financial performance and cash flows; and
• (b) the likelihood of the breach occurring.

Discussion

The Board approved recommendation 1 but rejected 2. In relation to recommendation 1, the Board also approved the factors that an entity might consider as proposed in (a) and (b) above.

The Board was concerned with how recommendation 2 would apply in practice specifically citing the example used in paragraph 17 of the agenda paper, where the existence of a covenant that required the debt:equity ratio to be below a specified number, might result in the entity’s having to ‘reduce the quantitative threshold against which materiality was assessed for both debt and equity to reflect the greater level of scrutiny that those amounts might attract’. The Board was concerned that materiality would become a moving target in that case subject to reassessment all the time which would be impractical. Having said that, one Board member thought that the materiality threshold should be dynamic and should reflect changes in the circumstances of a company; however, he didn’t believe that that should be translated into adjusting the materiality figure based on how close a covenant was to being breached. He also believed that the proposal would lead to a circular assessment of materiality as an entity would need to determine the materiality threshold before preparing its financial statements, yet the resulting gearing ratio would cause the entity to reassess materiality.

In addition, some Board members believed that a discussion of how the existence of a covenant affected the materiality assessment was outside the scope of the PS. They believed that the PS should distinguish between (a) assessing whether information about a covenant was material enough to warrant disclosure, and (b) how did the covenant affect the quantitative assessment of materiality. While (a) was within the scope of the PS as it related to the disclosure of information, (b) has arguably expanded beyond the scope and objective of the PS.

Disclosure Initiative: Materiality – Stewardship - Agenda paper 11C

Background

A few respondents asked the Board to clarify how the consideration of stewardship affects the materiality assessment.

Staff analysis and recommendation

The Staff recommended the following:

1. Including guidance in the PS to remind entities that information about how efficiently and effectively management discharges their responsibilities can be material.
2. Including an additional qualitative factor regarding stewardship in Step 2 of the Materiality Process (see Agenda Paper 11D of the October 2016 meeting).

Discussion

The Board approved the Staff’s recommendation, subject to redrafting the guidance to clarify that stewardship was one of the considerations in assessing whether information was useful, rather than presenting it as a separate independent qualitative characteristic of useful information. This would bring the guidance in the PS in line with that proposed in the revised Conceptual Framework.

One Board member was decidedly against the Staff’s recommendation because, in his view, it could be read as requiring disclosure on a broad range of things, some of which might be out of management’s control, as well as requiring the disclosure of piecemeal information on how management had managed the company.

In contrast, the other Board members agreed with the Staff. They commented that one of the main reasons for producing financial statements was to allow users to assess stewardship, therefore such information would be material. One Board member gave the following example: if advertising expense was regarded as an important expenditure in a particular industry, not disclosing it separately might fail to provide information that people needed to assess how well management had managed the company. Furthermore, another Board member stated that this issue was closely related to the corporate governance and internal controls of a company. He acknowledged that there were bound to be things that management could not control; but good corporate governance and internal control would require management to have implemented strategies to exploit the advantages and mitigate the disadvantages arising from these situations, and this was what stewardship was about. If there was a breach of these internal controls, that would be material information and should be disclosed in the financial statements. If management thought that they were not responsible for something, users would want to know about it.

Disclosure Initiative: Materiality – Recognition and measurement - Agenda paper 11D

Background

The ED contains a small section on the application of materiality in the context of the recognition and measurement of information. Respondents provided mixed feedback on the usefulness and appropriateness of including such a section in the PS. While some believed that more comprehensive guidance should be provided, others believed that this is not an area of pressing need or that the PS should focus exclusively on presentation and disclosure matters.

Staff analysis and recommendation

The Staff recommended the following:

1. Retaining the guidance on the application of materiality in the context of recognition and measurement but including the guidance throughout the PS, as opposed to in a separate section. The Staff believes that providing guidance on applying materiality in both a recognition and measurement context and a disclosure and presentation context on a topic by topic basis will be more helpful.
2. Including a description of the materiality practical expedients in the PS and describing the discipline that underlies the use of these practical expedients. That is, the entity should have a basis to reasonably expect that the effects on the financial statements of applying the expedients would not differ materially from not applying the expedients.

Discussion

The Board approved recommendation 1. With regard to the second recommendation, the Board agreed with including a description of the materiality practical expedients in the PS, albeit using a term other than ‘practical expedient’; however, there was no support for including a description of the discipline that underlay the use of these practical expedients similar to that included in the IFRS 15 and IFRS 16 practical expedients.

One Board member re-iterated his disagreement with the recommendations for the same reasons raised in the previous discussions.

There was not much discussion on the first issue.

With regard to the second issue, a few Board members suggested using another term to describe the ‘material practical expedients’ discussed in the PS. These Board members believed that the term ‘practical expedients’ should be reserved for cases that were described as such by the Board in various Standards. They believed that all practical expedients explicitly allowed by the Standards were granted after due deliberation by the Board and that the Board had specified what conditions must be satisfied before one could apply those practical expedients. These Board members believed that the distinction in vocabulary was necessary, firstly, to avoid the inadvertent association of these practical expedients with the assessment of materiality, and secondly, to prevent people from inappropriately analogising to the bases supporting the use of the practical expedients allowed in different Standards. The Staff agreed to amend the wording.

One Board member also requested the Staff to clarify the distinction, or the interrelationship, between materiality expedient and cost/benefit expedient as used in the examples in the agenda paper.

As regards describing the discipline that underlay the use of these practical expedients, the Staff emphasised their point that materiality should not be viewed as a short cut in deciding how to account for a transaction. It was a communication tool that had to be applied with a certain degree of discipline. IFRS 15 and IFRS 16 described the factors that an entity should consider when applying the practical expedients in those Standards. The Staff believed that those factors form the basis of the discipline which should apply equally to the more general guidance on materiality in the PS (i.e. there must be a reasonable basis on which one could conclude that applying the practical expedient would not result in a materially different answer than if the entity did not apply the practical expedient). The gist of the Staff’s argument was that any simplification to accounting on grounds on immateriality should be based on appropriate estimates and assumptions. However, the Board was concerned that the wording in the agenda paper did not reflect the intention of the Staff, and that the current wording suggested that entities could apply the practical expedients in IFRS 15 and IFRS 16 by analogy to other situations so long as the underlying bases for those practical expedients were met, without assessing whether something was material in accordance with the PS’s guidance.

Disclosure Initiative: Materiality – Entities applying the IFRS for SMEs Standard - Agenda paper 11E

Background

The ED is addressed only to entities applying full IFRS. This has led a few respondents to ask whether the PS should be made applicable to entities applying IFRS for SMEs.

Staff analysis and recommendation

The Staff recommended the following:

1. That the PS not be addressed to entities applying IFRS for SMEs. This is because the PS focuses on primary users of financial statements prepared using full IFRS. Their perspective may differ from the perspective of primary users of financial statements prepared using IFRS for SMEs.
2. Stating in the PS that some of the guidance in the PS might be useful in preparing financial statements in accordance with IFRS for SMEs.

Discussion

The Board unanimously agreed with recommendation 1 and disagreed with 2 on grounds that any reference to IFRS for SMEs would compel SMEs to read the whole PS to see what was useful for them and/or which sections might be applicable to them. This would be unduly burdensome for the SMEs.

Disclosure Initiative: Materiality – Status and form of the guidance - Agenda paper 11F

Background

The purpose of this paper was to ask the Board to confirm the publication of the guidance on materiality as a non-mandatory (as opposed to mandatory) guidance in the form of a practice statement (as opposed to other forms e.g. educational material).

Staff analysis and recommendation

The Staff recommended that the Board finalise the guidance in the form of a non-mandatory practice statement. This was in view of the feedback received and further analysis that indicates that a practice statement is the form that combines greater advantages and fewer disadvantages compared to other alternatives.

Discussion

The Board unanimously agreed with the Staff’s recommendation.