Re: Exposure Draft ED/2015/8 Application of Materiality to Financial Statements

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1 February 26, 2016 Mr. Hans Hoogervorst Chairman International Accounting Standards Board 30 Cannon Street London EX 4M 6XH United Kingdom Sent by to: Ms. Rebecca Villmann Director, Accounting Standards Accounting Standards Board 277 Wellington Street West Toronto, Ontario M5V 3H2 Sent by to: Dear Mr. Hoogervorst and Ms, Villmann, Re: Exposure Draft ED/2015/8 Application of Materiality to Financial Statements I appreciate the opportunity to provide my comments on the Draft Practice Statement in IASB s Exposure Draft ED/2015/8 Application of Materiality to Financial Statements. My comments are as follows: General Comments: Materiality is applied in determining disclosure depth across the financial statements and other public documents. Advancing the statement preparer s ability to effectively apply this concept will strengthen the quality of the corporate financial statements for stakeholders and hopefully improve comparability among peer companies. This Draft Practice Statement will enable preparers and reviewers to adopt a broader approach when relying on checklists and templates to determine minimum disclosure requirements while preparing financial statements. Specific Comments: Question 1 Form of the guidance A Practice Standard is not a Standard. The IASB s reasoning for issuing guidance on applying the concept of materiality in the financial statements in the form of a non-mandatory Practice Statement is set out in paragraphs BC10-BC15.

2 (a) Do you think that the guidance should be issued as non-mandatory guidance? Why or why not? (b) Do you think that a Practice Statement is the appropriate form for non-mandatory guidance on applying the concept of materiality? Why or why not? If not, what alternative(s) do you propose and why? Response 1 (a) The concept of materiality requires judgment. The related guidance issued is nonmandatory. Mandatory Practice Statements would require faithful application in order to be compliant with the Standards when declaring adherence in the Basis of Preparation part of the Notes to the Financial Statements. If the application is to be made mandatory, it would necessarily entail more detailed guidance from the standard setters. Measurable criteria such as quantitative thresholds, qualitative assumptions, key metrics noted by stakeholders, would be required to ensure the appropriate presentation of all materially relevant disclosures. Greater assistance, for a more consistent adoption of the concept, would be necessitated if this Practice Standard is mandated. I agree that from the standpoint of improving the quality of financial statements, globally, mandating a practical approach to the application of materiality is necessary. However, a mandated practice standard is only as good as the ability to regulate its application. Proper adoption controls for desired application would require additional guidance, assumptions and criteria from the Board (see Response 3). The Draft Practice Statement suggests that mandating the application of materiality might appear to be prescriptive and detract from the emphasis on management judgment. However, consistency and comparability across peer company financial statements can be better secured by mandating the basic tenets in the application of this concept. Response 1 (b) Agree. The IASB has previously issued Practice Statements to provide non-binding guidance on relevant matters in financial reporting and disclosure so this would be in keeping with its customary practices. Alternatively, this could become part of the Conceptual Framework for Financial Statements Materiality QC11. Its location would be more accessible and is more likely to be referred to by statement preparers as it would be well-positioned within the Handbook. Question 2 Illustrative examples Do you find the examples helpful in the (draft) Practice Statement? Do you think any additional practical examples should be included? If so, what scenarios should the examples address? Please be as specific as possible and explain why those example(s) would be helpful to entities. Response 2) The illustrative examples for the application of materiality by their very nature cannot be exhaustive. Including practical examples of materiality that affect some of the main line items in the financial statements, based on the recommended minimum disclosure in paragraphs 54, 81A, 81B and 82 of IAS 1, would serve as reference points when applying a quantitative approach to measure materiality, which would be helpful. Some additional more practical recommendations for material disclosure which would guide the preparer s thought process could include, for example - Purchases of

3 property, plant and equipment in the Cash used for investing activities portion of the Cash Flow Statement. Amounts relating to capital, such as exploratory capital or intellectual property investments intended to improve business operations could be discussed further in the notes or other disclosures to elaborate on the strategic or operational objectives of such expenditure. This would inform stakeholders as to the level of investment outlays incurred towards achieving the company s performance goals. The Draft Practice Statement should propose an approach that requires certain critical questions to be answered in order to determine the level of significance that should be assigned to a transaction. It should require an assessment of both qualitative and quantitative criteria on the financial operations of the entity. Based on the outcome of such assessments note disclosures or financial statement line item details could be determined. This will create more consistency across entity managements in the application of the concept. The present form of guidance does not allow for a systematic, step-by-step approach in reaching consistent and comparable conclusions across peer companies. Note disclosures should be organized more objectively to report on major transactions. Hedging transactions and risk diversification measures, repo and reverse repo arrangements and related collateral held and issued disclosures would improve cohesion in overall financial reporting on the entity s transactions. This would help provide quality information to stakeholders. Similarly, working capital elements such as, inventories, receivables and payables on most Balance Sheets are carried at significant values. Material disclosures could require that the continuity of balances for such accounts should accompany references to related financial statement line items providing stakeholders with comprehensive information on the operations. Operating efficiencies resulting in lower production costs, a quicker pace in receivable collections and controlled payables disbursement practices would provide useful information to stakeholders on the entity s cash flow management practices and ultimately in assessing the entity market value. The Draft Practice Statement should develop the materiality determining framework around core business transactions within major industries to inculcate a common understanding among preparers and auditors.

4 Question 3 Content of the (draft) Practice Statement The (draft) Practice Statement proposes guidance in three main areas: (a) characteristics of materiality; (b) how to apply the concept of materiality in practice when presenting and disclosing information in the financial statements; and (c) how to assess whether omissions and misstatements of information are material to the financial statements. It also contains a short section on applying materiality when applying recognition and measurement requirements. Please comment on the following and provide any suggestions you have for improving the (draft) Practice Statement: (a) Do you think that any additional content should be included in the Practice Statement? If so, what additional content should be included and why? (b) Do you think the guidance will be understandable by, and helpful to, preparers of financial statements who have a reasonable level of business/accounting knowledge and IFRS? If not, which paragraph/sections are unclear or unhelpful and why? (c) Are there any paragraphs/sections with which you do not agree? If so, which paragraphs/sections are they and why? (d) Do you think any paragraphs/sections are unnecessary? If so, which paragraphs/sections are they and why? (e) Do you think any aspects of the guidance will conflict with any legal requirements related to materiality within your jurisdiction, or a jurisdiction in which you file financial statements? Response 3) Material information and its influence on stakeholder decisions is determined by the degree to which their decision to hold, buy or sell their position in the entity could be confirmed, reinforced or altered. Such decisions are based on several factors from earnings to future performance to cash burn rate and capital investments. All of which lead to one question Valuation (the Holy Grail for investors). Does the information skew long term intrinsic value positively or negatively? This approach defines materiality of a transaction as one that is expected to have an impact on the future performance of the company. Example: capital expenditures expected to influence performance in future years by increasing income or reducing costs could be discussed. Similarly, where fair values are determined under Level 3 of the Fair Value Hierarchy, the materiality in terms of risk to capital or the entity s liquid resources should determine the detail of note disclosure. Likewise, derivatives which, undoubtedly, are entered into for speculative gains or hedging volatility could be discussed more succinctly in terms of net gains made or losses sustained as a result of the transactions. Separate disclosures under different note headings, particularly when the underlying hedged asset or liability is reported separately from the related derivatives, could often result in loss of information amidst the lengthy prose that accompanies every note. The Draft Practice Statement appears to be generalized in its structure as it relies on disclosure requirements mandated within IFRS. However, while the individual IFRS standards state disclosure requirements, they pertain to the policy related transaction. They do not provide materiality reference points or benchmarks for determining the degree of disclosure detail required. IFRS 8, Operating

5 segments utilizes both quantitative and qualitative criteria in the determination of reportable segments. The Draft Practice Statement should develop similar criteria, both qualitative and quantitative, to equip users with a practical approach in drawing conclusions on materiality. Related party transacting terms, however small, may draw stakeholder attention. Similarly, errors of omission or commission are best not committed but that would be wishful thinking. These may directly impact the current earnings and financial position of the company. Here too, the impact on investor/creditor expectations should be considered when determining if statement revisions are necessary. The Discussion Paper states that management could use an estimated percentage of profit or a percentage of revenues to determine what is likely to be material to the financial statements. Going back to the idea that materiality is entity specific may give rise to the notion that materiality could be determined to be a generalized percentage across all line items on the financial statements. But this is too broad-based as some line items or groups of items could be historically much lower than others. Materiality is relative and that has been sufficiently discussed, however, quantitative thresholds applied should take into account historical values, year on year volatility, where necessary, and be estimated for specific groups of reported values depending on their size and composition. I believe what should be emphasized is that materiality and quantitative values are not synonymous, as is generally accepted. Materiality of disclosure, regardless if it is in the financial statements or notes, should be based on its impact on current financial position, on the future operational performance and its influence on stakeholder decisions. Information, pertaining to income, expenses or capital assets and long term liabilities, capable of influencing a stakeholders opinion should require disclosure. If the values are negligible with barely any impact on the EPS, they are usually considered immaterial unless they have significant influence on future operations such as the early start-up costs of a new expansion, non-arm s length transactions or commitments and contingencies. Question to Canadian respondents: The IASB has developed the proposed amendments in accordance with its due process for application around the world. Assuming the Exposure Draft proposals are finalized and approved by the IASB in accordance with its due process, do you think that the proposed amendments are appropriate for application in Canada? If not, please specify which aspects of the proposed amendments, and what circumstances, make the accounting requirements proposed in the Exposure Draft inappropriate. Yes, the Draft Practice Statement is appropriate for application in Canada. Consistency in the application of the concept of materiality will improve the quality of disclosure in financial statements and accompanying notes, increase comparability across all IFRS compliant entities and help support the objectives of the standards.

6 If you have any questions please do not hesitate to contact me by at Yours sincerely, Lynessa Dias, CPA, CGA, CFA, FRM, CAIA