Materiality in Financial Reporting

Half Title Page......Page 1
Title Page......Page 2
Copyright Page
......Page 3
Dedication......Page 4
Contents......Page 5
List of Figures......Page 17
About the Author......Page 22
Preface......Page 23
Part I Introduction and Background......Page 26
1. Why Does Materiality Matter in Financial Statements?......Page 27
2. Powerful and Dangerous......Page 28
3. The Disclosure Framework......Page 29
4. The Disclosure Initiative......Page 30
5. The Disclosure Effectiveness Initiative......Page 31
6. Objectives of the Book......Page 32
Part II Conceptual Bases ofMateriality......Page 34
1.b. Level of Interaction in the Conceptual Frameworks......Page 35
1.c. A Pervasive Concept or a Qualitative Characteristic?......Page 36
1.d. Is Materiality a Constraint?......Page 40
1.f. Materiality versus Relevance......Page 41
1.g. Entity Specificity......Page 45
1.h. Materiality versus Reliability and Faithful Representation......Page 47
1.i. Completing the Picture: Materiality versus Completeness......Page 49
1.j. Materiality versus Understandability......Page 50
1.k. Does Prudence or Neutrality Affect Materiality?......Page 52
1.l. The Link to Recognition in the Conceptual Frameworks......Page 53
1.n. Impracticability versus Materiality......Page 55
1.o. Significance......Page 56
2.a. Can a Definition of Materiality Be Given?......Page 58
2.c. US Supreme Court’s Definition......Page 64
2.d. FASB (1985), CON 2......Page 65
2.e. SEC Rules and Regulations......Page 66
2.h. Common Conceptual Framework......Page 68
2.i. The International Financial Reporting Standards......Page 69
2.k. COSO Framework......Page 70
2.n. WRI and WBCSD......Page 71
3.b. What Is An Item?......Page 72
3.c. An Item versus Its Content......Page 73
3.d. Omissions or Misstatements......Page 74
3.f. Materiality Test from Users’ Perspective......Page 75
3.g. Materiality Test Contrasted with the Objective of General-Purpose Financial Statements......Page 76
3.j. Reasonable Investor and Reasonable Person......Page 77
3.l. Primary versus Intended versus Other Users......Page 78
3.m. Stakeholders versus Users......Page 79
3.o. Degree of Likelihood......Page 80
3.p. Understanding Influence versus Influencing......Page 82
3.r. Context......Page 84
3.t. Time Horizon......Page 85
Paragraph 1.b......Page 86
Paragraph 1.f......Page 87
Paragraph 1.j......Page 88
Paragraph 2.b......Page 89
Paragraph 3.d......Page 90
Paragraph 3.p......Page 91
Conclusion......Page 92
Part III Actors and Models ofMateriality......Page 94
1.a. Is Materiality Exclusively a Legal Concept?......Page 95
1.b. Are Legal and Accounting Definitions of Materiality Incompatible?......Page 96
1.c. Practical Interactions of Legal and Accounting Concepts of Materiality......Page 98
1.d. The Different Nature of an Accounting Concept of Materiality......Page 99
1.e. The Quest for an Accounting Definition of Materiality......Page 100
1.f. Materiality in Audit versus in Financial Statements......Page 101
1.g. Other Uses of Materiality by Auditors......Page 102
2.a. Who Allows Materiality?......Page 104
2.c. Who Decides Materiality?......Page 105
2.d. Who Assesses Materiality?......Page 106
3.b. A Positive versus a Negative Concept......Page 107
3.c. A Discrete versus a Continuous Notion......Page 108
3.d. Different Disclosure Regimes......Page 110
3.f. Probability/Magnitude Mapping......Page 111
3.g. Severity of Deviancies......Page 115
3.j. Statistical Use of Information......Page 116
3.k. Doctrine of Differential Disclosure......Page 117
3.l. Expanded Dimensions of Materiality......Page 120
3.m. The Flexibility Zone......Page 122
3.n. Eyes of Management versus Eyes of Investors......Page 123
3.o. The Ownership Triangle......Page 125
3.p. Active versus Passive Role......Page 126
3.q. The Sender–Receiver Distortion......Page 127
3.s. Objective versus Subjective Determination......Page 128
3.u. Consensus Materiality......Page 129
3.v. Adjustment Method......Page 130
3.x. Qualitative Factors......Page 131
Paragraph 1.a......Page 132
Paragraph 1.g......Page 133
Paragraph 3.d......Page 134
Paragraph 3.m......Page 135
Paragraph 3.t......Page 136
Conclusion......Page 137
Part IV Application of Materiality......Page 138
1.a. Does Materiality Apply to Recognition and Measurement?......Page 139
1.d. Significant Accounting Policies......Page 140
1.g. Materiality in Disclosing Voluntary Changes in Accounting Policies......Page 142
1.h. Materiality in Disclosing Involuntary Changes in Accounting Policies......Page 143
1.i. The Case of Accounting Errors......Page 144
2.a. Does Materiality Apply to Presentation and Disclosure?......Page 145
2.c. Required Disclosure of Immaterial Information......Page 147
2.d. Allowed Disclosure of Immaterial Information......Page 148
2.e. The Disclosure Overload Debate......Page 149
2.f. Obscuring Material Information......Page 150
2.g. Minimum Set of Required Disclosures......Page 151
2.h. Classification......Page 152
2.i. Interaction of Aggregation and Disaggregation of Information......Page 153
2.j. Top-down Model of Disaggregation in the Financial Statements......Page 154
2.k. Bottom-up Model of Aggregation in the Financial Statements......Page 155
2.l. Classes of Aggregation......Page 157
2.m. Alternative Model of Aggregation in the Financial Statements......Page 158
2.n. General Models of Disaggregation for Disclosure Purpose......Page 159
2.o. Review Assessment......Page 162
2.q. Material Items......Page 163
2.r. Disclosure Objectives......Page 164
2.t. Effect of Measurement Bases......Page 165
2.v. Rounding......Page 166
2.w. When Required Disclosure Is Not Enough......Page 167
3.a. Management Commentary versus the Notes......Page 168
3.b. Views of Materiality in Management Commentary......Page 169
3.c. Material Known Trends or Uncertainties in SEC’s MD&A......Page 170
3.e. Critical Accounting Estimates in MD&A......Page 174
3.g. Segment Analysis......Page 175
4.a. Bookkeeping versus Financial Statements: A Separate Perspective......Page 176
4.b. Bookkeeping versus Financial Statements: An Integrated Perspective......Page 177
4.d. The Indirect Impact on Financial Statements of Bookkeeping Errors......Page 178
4.e. The Delicate Link to Intentional Immaterial Errors......Page 179
4.g. Can Immaterial Bookkeeping Errors Be Left Uncorrected?......Page 180
4.i. Reasonableness versus Materiality......Page 181
4.j. Legal Implications......Page 182
4.k. Should Accountants Care of Materiality at All?......Page 183
5.a. Audit Definition of Materiality......Page 184
5.b. Definition of Material Misstatement......Page 185
5.c. The Risk of Material Misstatements and Assertions......Page 186
5.d. Relationship between Audit Risk and Materiality......Page 187
5.e. Iteration of Materiality and Inherent Risk......Page 190
5.g. Timing of Auditor’s Consideration of Materiality......Page 191
5.i. How Materiality Affects Auditors’ Responses to Misstatements......Page 193
5.j. How Materiality Affects Auditors’ Responses to Fraud......Page 194
5.k. How Materiality Affects Auditors’ Responses to Illegal Acts......Page 195
5.l. Communications with the Management, Internal Auditors, and Audit Committee......Page 196
6.a. Internal Control over Financial Reporting versus Audit......Page 197
6.b. Materiality and Technical Classifications of Internal Control Deficiencies in SOX......Page 198
6.c. Materiality and Internal Control Deficiencies in COSO Framework......Page 199
6.e. Definition of Risk......Page 200
6.f. Risk Tolerance......Page 201
6.h. Risk Appetite and Risk Tolerance in the Context of Corporate Guidance Systems......Page 202
6.i. Interlock of Risk, Risk Appetite, Risk Tolerance, and Precision of Internal Controls......Page 203
6.j. Relationship between Risk Tolerance and Materiality......Page 205
6.l. Relationship between Risk Tolerance and Precision of Controls......Page 206
6.n. Other Drivers of the Precision of Controls......Page 208
6.o. The Importance of Immaterial Misstatements in ICOFR......Page 209
6.q. Role of Materiality in Testing ICOFR......Page 210
6.r. Management Review Controls......Page 211
Solutions and Recommendations......Page 212
Paragraph 2.c......Page 213
Paragraph 2.l......Page 214
Paragraph 2.u......Page 215
Paragraph 3.g......Page 216
Paragraph 4.f......Page 217
Paragraph 5.c......Page 218
Paragraph 5.k......Page 219
Paragraph 6.h......Page 220
Paragraph 6.p......Page 221
Conclusion......Page 222
Part V Assessing Materiality......Page 223
1.a. Quantitative versus Qualitative Criteria......Page 224
1.c. Is Magnitude Exclusively a Quantitative Concept?......Page 226
1.d. What Is the Meaning of Qualitative?......Page 227
1.f. When a Fact Is Always Material......Page 228
1.g. Management Discretion......Page 232
1.h. Auditor and Other External Professional Judgment......Page 234
1.i. How Can the Management Judgment Be Professional?......Page 235
1.j. What Is the Scope of Professional Judgment?......Page 236
1.l. When Is the Judgment Process Professional?......Page 237
1.n. How to Evaluate Judgment Reasonableness?......Page 238
1.o. Changes in Judgment and Reassessment......Page 240
2.b. Role of Quantitative Thresholds......Page 241
2.c. The Case of an Absolute Dollar Amount......Page 242
2.e. When a Large Misstatement Can Be Immaterial......Page 243
2.f. Performance Materiality......Page 245
2.i. Should the Management Use Materiality Set by Auditors?......Page 247
3.a. The Concept of Whole Financial Statements......Page 248
3.c. Materiality at Lower Levels......Page 249
3.e. Component Materiality......Page 251
4.a. Common Benchmarks......Page 255
4.c. Rules of Thumbs Used in Practice......Page 256
4.d. Choosing Benchmarks......Page 258
4.e. Normalizing Benchmarks......Page 259
4.g. Volatility......Page 260
4.i. Capital Structure......Page 261
4.k. Pervasiveness......Page 262
5.a. Basic Period in Focus......Page 263
5.c. Corresponding Figures versus Comparative Financial Statements Approach......Page 264
5.e. Materiality in Future Periods......Page 267
5.f. Uncorrected Immaterial Misstatements Adding Up to Materiality in the Current Period......Page 268
5.h. Effect of Misstatement of Comparative Information......Page 274
5.i. Counterbalancing and Noncounterbalancing Misstatements......Page 275
5.k. Effect on Financial and Forensic Analysis......Page 276
6.a. Risk of Material Misstatement of an Accounting Estimate......Page 277
6.c. The Linkage between Estimation Uncertainty and Materiality......Page 278
6.d. Judgmental Misstatements......Page 280
6.e. The Linkage between Inherent Imprecision and Misstatements......Page 281
6.f. Management Bias......Page 282
6.h. Linkage between Materiality and Sources of Estimation Uncertainty......Page 283
6.i. Critical Accounting Estimates......Page 284
7.a. Analysis at Individual Item Level......Page 285
7.c. Offsetting Misstatements......Page 286
7.e. Trends and Ratios......Page 287
8.a. Assessing Decisions......Page 288
8.c. Approaches to Verify Materiality Ex Post......Page 289
8.d. The Implication in Terms of Accounting Changes......Page 290
9.a. Does GAAP Really Not Apply to Immaterial Items?......Page 291
9.c. Intentional Immaterial Misstatements......Page 293
9.d. Does Intention Make a Misstatement Always Material?......Page 294
9.f. The Difference between Achieving a Particular Presentation and Influencing Users......Page 295
9.h. A Policy to Ignore Immaterial Misstatements......Page 296
9.j. Material Effect of Accumulation of Immaterial Errors......Page 297
9.k. Correction of Immaterial Errors......Page 298
9.n. Summary of Treatment of Errors......Page 299
10.a. Reference Period of Materiality under IFRS......Page 301
10.c. Materiality in Interim Reporting for Correction of Errors......Page 302
10.d. Materiality in Interim Reporting for Changes in Estimates and Changes in Accounting Policies......Page 303
10.e. Relationship between Materiality to Interim and to Annual Financial Statements......Page 304
10.f. Relationship between Estimation Uncertainty and Materiality in Interim Periods......Page 305
10.h. Audit Considerations......Page 307
10.i. Interim Periods in MD&A......Page 308
11. Assessing Materiality in Segment Reporting......Page 309
Paragraph 1.d......Page 311
Paragraph 1.k......Page 312
Paragraph 2.d......Page 313
Paragraph 3.c......Page 314
Paragraph 4.e......Page 315
Paragraph 5.a......Page 316
Paragraph 5.g......Page 317
Paragraph 6.c......Page 318
Paragraph 6.j......Page 319
Paragraph 8.e......Page 320
Paragraph 9.h......Page 321
Paragraph 10.b......Page 322
Paragraph 10.i......Page 323
Conclusion......Page 324
Part VI The Materiality Determination Process......Page 325
1.b. Frameworks to Determine Materiality......Page 326
2.b. The IASB’s Four-Step Approach......Page 327
3.b. Audit Red Alerts......Page 328
3.c. Materiality Benchmark Selection......Page 334
4.b. Heat Maps......Page 335
5.a. Materiality Determination in Integrated Reporting......Page 336
5.b. Materiality Determination in AA1000......Page 337
5.c. The Materiality Matrix......Page 338
5.e. Significance/Influence Matrix......Page 339
6.a. The Integrated Reporting Disclosures of the Materiality Process......Page 340
7.a. General Disclosures in Accounting Standards......Page 341
7.b. General Disclosures in Audit Standards......Page 342
7.d. Disclosure of Material Aspects in Sustainability Reporting......Page 343
Solutions and Recommendations......Page 344
Paragraph 4.b......Page 345
Paragraph 7.a......Page 346
Conclusion......Page 347
Part VII Where Standard Specifically Require Materiality Judgments......Page 348
2. What Standards Say Users Want......Page 349
3. The Notion of Inconsequential or Perfunctory......Page 363
5. Related Parties......Page 364
Paragraph 2......Page 368
Conclusion......Page 369
Part VIII Accounting Materiality in the Real World......Page 370
2. Improvement of the Effectiveness of Financial Statements: The Standard-Setters' View......Page 371
3. Behavioral Issues......Page 372
4. Is There Something Missing?......Page 373
5. Materiality Comments on SEC Staff IFRS Reviews......Page 374
6.a. Uses and Misuses of Materiality......Page 377
6.c. Below Materiality Threshold......Page 378
6.d. Setting Materiality High......Page 379
6.g. Offset......Page 380
6.i. Income Statement Orientation......Page 381
6.j. The Presentation versus Disclosure Game......Page 382
6.m. Contra-Asset and Provision Items......Page 383
6.o. Unbundling Misstatements......Page 384
6.p. Statements Were Audited......Page 385
6.q. Absolute Amounts......Page 386
6.s. Too Far in Time......Page 387
6.u. Management Commentary......Page 388
6.w. Reclassifications and Continuous Restatement......Page 389
6.x. Change in Judgment......Page 390
6.z. Focus on Consolidated Financial Statements......Page 391
6.bb. Shooting a Moving Target......Page 392
6.cc. Persistent Behaviors......Page 393
Paragraph 1......Page 394
Conclusion......Page 395
References......Page 396
Index......Page 420