Exposure Draft IFRS Practice Statement Application of Materiality to Financial Statements

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1 Deloitte Touche Tohmatsu Limited 2 New Street Square London EC4A 3BZ United Kingdom Tel: +44 (0) Fax: +44 (0) Direct: Direct fax: vepoole@deloitte.co.uk Hans Hoogervorst Chairman International Accounting Standards Board 30 Cannon Street London United Kingdom EC4M 6XH 26 February 2016 Dear Mr Hoogervorst Exposure Draft IFRS Practice Statement Application of Materiality to Financial Statements Deloitte Touche Tohmatsu Limited is pleased to respond to the International Accounting Standards Board s (the IASB s) exposure draft of a proposed Practice Statement on the Application of Materiality to Financial Statements. We support strongly the Board s Disclosure Initiative and commend the Board for its efforts to date. We continue to believe that the Initiative should be given high priority by the IASB. Many reports cite a lack of understanding of how to apply materiality to the explanatory notes as contributing to the problem. 1 We agree. We think that sensible application of materiality principles can lead to financial statements that are more fair, balanced and understandable i.e. more useful. We therefore welcome the IASB s efforts to improve how materiality is applied. We think the proposed practice statement is an important step in improving the understanding of materiality. In our view, ultimately non-mandatory guidance may not be the right place to set out the principles and guidance included in the proposal. Some parts of the proposed guidance would be helpful additions to the Conceptual Framework. Other sections would make helpful application guidance within IFRS, in the eventual replacement for IAS 1 Presentation of Financial Statements. However, in the context of where IFRS is today we think that non-mandatory guidance, and a practice statement in particular, is the best form and we strongly support the IASB giving priority to finalising the guidance. 1 EFRAG: Towards a disclosure framework for the notes, UK FRC: Towards a disclosure framework for the notes; Thinking about disclosures in a broader context; Cutting clutter; and ICAS/NZICA Losing the excess baggage. Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as Deloitte Global ) does not provide services to clients. Please see for a more detailed description of DTTL and its member firms. Deloitte Touche Tohmatsu Limited is a private company limited by guarantee incorporated in England & Wales under company number , and its registered office is Hill House, 1 Little New Street, London, EC4a, 3TR, United Kingdom.

2 The IASB should see the development of this non-mandatory guidance as the first step in a longer journey to develop sound principles and guidance for applying materiality, and not the end of the process. We think that it is important that the IASB monitor the use and effect of the practice statement once it has been issued. Feedback on its application should help the IASB assess whether it should propose changes to the definition of materiality or to propose adding some of the guidance to the eventual replacement of IAS 1. It will be important to assess how the Practice Statement is used in different jurisdictions, including whether it is endorsed or referenced by authoritative bodies. It will be particularly important to assess whether there are any issues that could suggest conflicts between the guidance in the practice statement and how materiality is applied by specific securities regulators, courts and those involved in other areas of corporate reporting, and also how it is addressed in professional auditing standards. We are aware that some securities regulators have expressed a preference for the guidance to be in a Standard, to provide authoritative guidance from the IASB. Other securities regulators are concerned that any formal guidance from the IASB, even in the form of a non-mandatory practice statement, runs the risk of conflicting with regulatory requirements. In our detailed responses to the invitation to comment we have made many suggestions about how we think the drafting could be improved or additions could be made to make it more helpful. However, none of those suggestions are in disagreement with the technical decisions reflected in the draft. We are also submitting for your consideration our recent publication on materiality, from our Thinking Allowed series. We think that some of the concepts expressed in that document could be helpful to the IASB in finalising the practice statement. We used this document to help us analyse the proposed practice statement. If you have any questions concerning our comments, please contact me in London at +44 (0) Yours sincerely Veronica Poole Global IFRS Leader Page 2

3 Appendix A Deloitte responses to the Invitation to Comment Question 1 - Form of the guidance A Practice Statement 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. (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? Responses (a) Do you think that the guidance should be issued as non-mandatory guidance? Why or why not? Non-mandatory guidance Our answer to this question reflects our view that the IASB should see the development of this non-mandatory guidance as the first step in a longer journey to develop sound principles and guidance for applying materiality, and not the end of the process. In our view, ultimately non-mandatory guidance may not be the right place to set out the principles and guidance included in the proposal. Some parts of the proposed guidance would be helpful additions to the Conceptual Framework. Other sections would make helpful application guidance within IFRS, in the eventual replacement for IAS 1 Presentation of Financial Statements. However, in the context of where IFRS is today we think that non-mandatory guidance, and a practice statement in particular, is the best form and we strongly support the IASB giving priority to finalising the guidance. Monitoring We think that it is important that the IASB monitor the use and effect of the practice statement once it has been issued. Feedback on its application should help the IASB assess whether it should propose changes to the definition of materiality or to propose adding some of the guidance to the eventual replacement of IAS 1. At a basic level, it will be important to monitor and assess how the Practice Statement is used in different jurisdictions, including whether it is endorsed or referenced by authoritative bodies. It will be particularly important to assess whether there are any issues that could suggest conflicts between the guidance in the practice statement and how materiality is applied by specific securities regulators, courts and those involved in other areas of corporate reporting, and also how it is addressed in professional auditing standards. Page 3

4 (a) 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? We are aware that some regulators have expressed a preference for the guidance to be in a Standard, to provide authoritative guidance from the IASB. Other regulators are concerned that any formal guidance from the IASB, even in the form of a non-mandatory practice statement, runs the risk of conflicting with regulatory requirements. If the guidance is to be non-mandatory, we think that a Practice Statement is an appropriate form for this purpose. The IASB has a more disciplined due process for the development of a Practice Statement than it does for educational material or other ad hoc publications. This more formal process is particularly important for dealing with a concept as central to IFRS as materiality. We have been, and remain, of the view that piecemeal changes to Standards (including IAS 1) should be avoided if they delay the Disclosure Initiative and the replacement of IAS 1. However, a practice statement is a less obtrusive way for the IASB to get some guidance in place, and in a way that could provide helpful and timely input into the Disclosure Initiative. Page 4

5 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 We think that in the context of a practice statement, providing practical examples can be very helpful. We understand the challenge of creating examples that are neither too specific nor too general to be helpful. We do not have any concerns with the examples in included in the proposed practice statement, but we have suggested some editorial and formatting changes to the draft. The latter suggestion is aimed at separating the larger or more complex examples from the general flow of the text. We think the areas for which additional examples would be helpful are: Identifying primary users we have included in our suggestions an example related to stewardship, which is consistent with our suggestion to expand the discussion on stewardship. Assessing when items that are individually immaterial should be viewed as material collectively. Prior period errors how prior period errors affect the materiality assessment in the current period. Disclosure-only standards - we have suggested adding an example from IFRS 12 Disclosure of Interests in Other Entities. The nature of uncertainties. Specific balance materiality. Matters that affect OCI, but not profit or loss we think it would be helpful to clarify that the fact that a matter affects other comprehensive income but not profit or loss does not automatically make that matter less important. A preparer should still be required to assess the effect of that information on the financial statements as a whole. We have suggested examples that address these topics in the marked-up version of the practice statement attached in Appendix B. Page 5

6 Question 3 - Content of the [draft] Practice Statement The [draft] Practice Statement proposes guidance in three main areas: (a) (b) (c) characteristics of materiality; how to apply the concept of materiality in practice when presenting and disclosing information in the financial statements; and 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) (b) (c) (d) (e) Do you think that any additional content should be included in the Practice Statement? If so, what additional content should be included and why? 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 paragraphs/sections are unclear or unhelpful and why? Are there any paragraphs/sections with which you do not agree? If so, which paragraphs/sections are they and why? Do you think any paragraphs/sections are unnecessary? If so, which paragraphs/sections are they and why? 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? Responses (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? Judgement Framework The practice statement is missing a judgement framework that provides an overview of the factors that need to be considered when a preparer is making judgements about materiality. We think this would be helpful, because it helps frame (structure) the practice statement. We have provided some suggestions for how this could be worded. Presentation and emphasis How information is presented is part of the materiality assessment, because presentation can affect its usefulness and how it is perceived by users of the financial statements. We think it would be helpful to add a section on presentation and emphasis, with some examples. We have provided some suggestions for such a section. Entity-specific information The financial statements should provide information that is specific to the entity, because this provides more useful information and removes some of the less helpful generic or Page 6

7 boiler-plate information. This is particularly relevant to the notes accompanying the financial statements. It is a theme that is important in the Disclosure Initiative and we think that it would be helpful to emphasise this in the practice statement. Accounting policies could be used as an example. Stepping back Materiality assessments are made in the context of the financial statements as a whole. It is therefore important for a preparer to assess the set of financial statements once it has been compiled to identify any matters that should be addressed, by adding, removing or emphasising information. This step is missing from the practice statement. Documenting and disclosing the judgement process The IASB does not specify what sort of documentation an entity must keep. Nevertheless, some IFRSs have implicit requirements for internal documentation. For example, the portfolio practical expedient in IFRS 16 Leases requires that the entity have a reasonable expectation that the using the expedient would not differ materially from applying the Standard to the individual leases. IFRS 5 Non-current Assets Held for Sale and Discontinued Operations sets out the indicators of a commitment to sell an asset. In the same way that good documentation can support important accounting judgements, it could be helpful to note in the practice statement the benefits of the preparer documenting how they have made their materiality judgements. The IIRC Framework states that an integrated report should include an explanation of the entity s materiality determination process. We think there could be benefits from encouraging entities to disclose information that helps the primary users of the financial statements understand how they assessed materiality. Relatedly, materiality judgements are made at a point in time on the basis of information available at that time. If such a judgement is challenged at a later date, there might be new information available that gives the challenger the benefit of hindsight. If the decision process has been documented, and disclosed, it should be helpful in explaining what process the preparer went through at the time those initial judgements were made. We have not included any specific wording for implementing these suggestions, but would be happy to do so. Relationship with International Auditing Standards Auditing standards set out factors that an auditor must consider in conducting an audit and factors that must be considered in assessing the financial statements as a whole. Those assessments might differ from the assessments made by those preparing the financial statements. We considered whether it would be helpful to explain some of the areas of potential difference, and perhaps include some references to professional auditing standards. Page 7

8 However, although it is important to understand these differences, we think the practice statement should focus on the preparation of financial statements, and not their audit. (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 paragraphs/sections are unclear or unhelpful and why? Overall we think this has the potential to be a helpful document. We have provided detailed drafting suggestions on the edited version of the practice statement included with this comment letter. (c) Are there any paragraphs/sections with which you do not agree? If so, which paragraphs/sections are they and why? We have identified what we assume to be a drafting problem, as opposed to a problem with the technical decision, in paragraphs 78 and 79. These paragraphs can be read to mean that any decision not to comply with an accounting policy must have been made with the intention of misleading the users of the financial statements and the consequences of all such decisions must therefore be material. We explain in our response to Question 5 why we think this is a fatal flaw, and we have suggested changes that differentiate more clearly between the examples in paragraphs 79(a) and 79(b). (d) Do you think any paragraphs/sections are unnecessary? If so, which paragraphs/sections are they and why? The draft reproduces paragraphs from other IASB literature. In several cases we think that the practice statement would be improved, and be more readable, if the main themes in those paragraphs were integrated in the text. An example is paragraph 20, which reproduces four paragraphs from the objectives of the Conceptual Framework. We have suggested how this could be achieved in the edited draft included with our comment letter. (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? The IASB s definition of materiality is not the only definition relevant to entities preparing financial statements in accordance with IFRS. Other, similar, definitions have been developed within the legal frameworks of some jurisdictions. Although there are differences in wording, our assessment of the most common definitions of materiality is that they share a theme. In plain language, applying materiality involves assessing the likelihood that including or excluding information, or changing how it is presented, will affect the decisions being made by the primary users of the financial statements. An entity preparing IFRS financial statements will need to be sensitive to how materiality is defined and applied in a particular jurisdiction. For example, an entity filing its IFRS financial statements in the U.S. will need to be aware of how the U.S. Supreme Court definition, and the guidance provided by the U.S. SEC., affect materiality judgements. The IAS 1 definition refers to an item being material if it could influence [an] economic decision whereas the U.S. Supreme Court decision refers to whether there is a substantial likelihood that the disclosure or omitted fact would have been viewed by a Page 8

9 reasonable investor as having significantly altered the total mix of information (emphasis added). Foreign registrants have been filing financial statements without reconciliation to U.S. GAAP since We are not aware of any issues having been caused by the different definitions of materiality. Nevertheless, we have emphasised that the IASB will need to monitor the effect of the practice statement and we recommend that they liaise closely with IOSCO in this regard. We also note that materiality assessments can be influenced by local factors, including local regulations. This means that some matters could be considered material to the primary users of the financial statements in one jurisdiction, but not in others. For example, a local regulator might specify that it is particularly interested in how a type of construction contract is accounted for because of concerns about some contracts that are specific to some local legislation. Such action would be a factor that a preparer in that jurisdiction would consider in making materiality judgements. In a similar manner, local customs or values can make some matters more, or less, important to the primary users of the financial statements. Page 9

10 Question 4 - Timing The IASB plans to issue the Practice Statement before the finalisation of its Principles of Disclosure project. The IASB has tentatively decided to include a discussion on the definition of materiality, and whether there is a need to change or clarify that definition within IFRS, in the Discussion Paper for its Principles of Disclosure project (expected to be issued early in 2016). Nevertheless, the IASB thinks that to address the need for guidance on the application of materiality, it is useful to develop the Practice Statement now. The IASB does not envisage that the discussion about the definition of materiality or any other topics in its Principles of Disclosure project will significantly affect the content of the Practice Statement. Nevertheless, the IASB will consider whether any consequential amendments to the Practice Statement are necessary following the completion of the Principles of Disclosure project. Do you agree with this approach? Response As we emphasised in our responses to Question 1, we consider the publication of a Practice Statement would be a helpful step in improving the application and understanding of materiality. Although we are reluctant to have guidance developed in a piecemeal manner, the development of a practice statement seems to be a reasonable way of providing some guidance without constantly updating IFRS. We do not see the Practice Statement as pre-judging the work of the Principles of Disclosure project, or slowing down that work. To the contrary, if the IASB monitors the effect of the practice statement, the observations and feedback could be helpful input for the IASB. Our initial assessment suggests that in some jurisdictions preparers and regulators are already thinking about how to use the practice Statement. The current timetable suggests that it will be 2017 before the IASB can start to consider comment letters it receives on the planned Principles of Disclosure DP. Even with a relatively smooth development process for any replacement of IAS 1, the Practice Statement could be relevant for five or more years. We therefore support the publication of a practice statement now rather than waiting for the principles of disclosure work to pick this up. And we encourage the IASB to move quickly to finalise the proposed Practice Statement. Page 10

11 Question 5 - Any other comments Do you have any other comments on the [draft] Practice Statement? As mentioned in Question 4, a discussion about the definition of materiality will be included in the Discussion Paper in the Principles of Disclosure project, so the IASB is not asking for comments on the definition at this time. Response Practical expedients and uncorrected errors Practical expedients Every day, entities make decisions to simplify how they account for transactions that are clearly immaterial to its performance, position and cash flows (e.g., accounting conventions). Those simplifications conflict with the requirements in IFRS. For example, an entity might expense on acquisition assets with a cost below a specified threshold, even though they meet the definition of property, plant and equipment. Similarly a lease might meet the definition of a finance lease, but the entity might expense the payments as they are made rather than recognising a lease asset and a lease obligation if the amounts involved are small. In both cases the entity will have assessed that the difference between the simplified accounting and complying with IFRS is not material. Yet, in both cases, the departures from IFRS are deliberate and they are, technically, misstatements. We think the practice statement could helpfully clarify that these simplified recording processes or accounting conventions do not prevent the financial statements from complying with IFRS, even though they are deliberate, provided that the entity has assessed that the differences in outcomes would not have a material effect on the amounts reported in the financial statements. We also emphasise that entities are generally subject to requirements to keep adequate records. In our view, these pragmatic simplifications to how information is reported are not incompatible with an entity s record keeping obligations. Uncorrected errors During the preparation of the financial statements an entity or its auditors will sometimes identify errors. Paragraph 71 of the proposed practice statement describes the causes of typical errors, including of arithmetical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud (such as an employee misappropriating funds). The practice statement also notes that correcting an immaterial error may be unduly costly or delay publication of an entity s financial statements. A decision not to adjust for immaterial errors is supportable if it is made on the basis that correcting them would not have a material effect on the financial statements and that investors would not be affected by the failure to correct. We support that analysis and conclusion. However, there is a tension between that discussion and the notion that deciding not to correct an error is always deemed to be deliberate and any deliberate misstatement is material. We have suggested some changes to paragraphs 78 and 79 to make it clear that failure to correct immaterial errors Page 11

12 does not prevent the financial statements from complying with IFRS, even though that decision is deliberate, provided that the entity has assessed that the differences in outcomes would not have a material effect on the amounts reported in the financial statements. Drafting Although we have no difficulty reading and understanding the document, we think it can be improved in several ways. Our main suggestions are related to removing some of the repeated sections, removing some of the quoted paragraphs from other documents and instead integrating the relevant information in the main text, reformatting examples and simplifying some of the sentences. The objective is to ensure that the principles are expressed more concisely, supported by examples. Although we have provided extensive suggestions for improving the practice statement, those suggestions focus on core issues. We have not undertaken a systematic review of the drafting. We think the final draft would benefit from a rigorous editorial review, to simplify the text and remove duplicate material. Structure We have suggested moving some sections to improve the flow of the document. For example, the section on primary financial statements could be brought forward, because we think that in the discussion of aggregation the references to presentation quoted from IAS 1.29 to 30A relate to the primary financial statements rather than the financial statements as a whole i.e. including the notes. We think the discussion of aggregation should be associated with the primary financial statements because the proposed practice statement has a separate discussion on note disclosures. We have also suggested moving the section on interim financial statements to the end of the document. The draft practice statement has been written with an annual financial report in mind. Although it is helpful to have a discussion about interim financial statements, it would be better to treat this as a separate topic. Omissions We have suggested some new sections, or paragraphs, for the following topics: Decision framework the document suffers from the absence of a framework that draws the important elements of materiality together. Stewardship this section should be expanded to explain how stewardship could affect materiality assessments. Reviewing the draft financial statements an important step in applying materiality is to step back and assess whether, taken as a whole, the financial statements present fairly the financial position, financial performance and cash flows of the entity. Such an assessment could lead to the entity removing immaterial information that detracts Page 12

13 from, or obscures, material information. Equally, it could lead to the entity adding information to address gaps. Specific language we think it would be helpful to emphasise that information that is specific to the entity is likely to be more helpful to the primary users. This is relevant to materiality because generic or boiler-plate can detract from or obscure material information. Presentation and emphasis although there are some references to how information is presented and emphasised, we think this topic deserves to be given more prominence. Simplifications Rather than quoting whole sections of the Conceptual Framework or Standards, the main points could be summarised and integrated into the main text. We think this would make the text flow better, and it will reduce the length of the document. Basis for Conclusions We think it would be helpful if the IASB provided clearer explanations about why they consider that removing immaterial information helps the primary users of the financial statements. We are aware that some users are concerned that the discussions on materiality are being used to justify reducing the amount of information that is available to them. Those users would rather have more information and make their own assessments about which information to discard. We support the direction the practice statement is taking, but we are concerned that the basis for conclusions does not set out clearly enough why those investors should also support it. Page 13

14 Exposure Draft IFRS Practice Statement Application of Materiality to Financial Statements Appendix B Drafting suggestions IFRS Practice Statement Application of Materiality to Financial Statements Objective 1 The objective of this [draft] IFRS Practice Statement Application of Materiality to Financial Statements (the [draft] Practice Statement ) is to assist management in applying the concept of materiality to general purpose financial statements prepared in accordance with International Financial Reporting Standards (IFRS) and to help the users of financial statements understand how management assesses materiality. Scope 2 This [draft] Practice Statement is intended to be applied in preparing general purpose financial statements in accordance with IFRS. 3 Sometimes information is incorporated in the financial statements by cross-reference to another statement, such as a management commentary or risk report, that is available to users of the financial statements on the same terms as the financial statements and at the same time. 1,2 Without the information incorporated by cross-reference, the financial statements are incomplete. This [draft] Practice Statement also applies to information that is incorporated by cross-reference. General characteristics of materiality Introduction 4 Materiality is a general concept that is widely used both in financial reporting and for other purposes. For example, it is common for legal agreements to refer to material information, usually within a specific context such as referring to material changes to the terms of the offer which may or may not be financial in nature. 5 In many jurisdictions there are requirements that oblige listed entities to keep investors informed about aspects of their business on an ongoing basis. For example, during a takeover bid the parties might be required to keep markets informed about the terms of the takeover offer. There might also be ongoing obligations, beyond the requirement to file financial statements, to disclose price-relevant information known to the entity. Some jurisdictions use materiality principles, and supplementary guidance, to enforce these obligations. For example, an exchange may have guidelines on when a listed company issues a profit warning. These guidelines have probably been developed by considering the point at which information becomes material and should be publicly disclosed. 6 The way in which the term materiality is understood in the contexts above is expected to be consistent with the way in which the term is expected to be applied to financial reporting. However, IFRS contains 1 Throughout this [draft] Practice Statement, the term financial statements refers to general purpose financial statements unless specifically indicated otherwise. 2 For example, see paragraph 21B of IFRS 7 Financial Instruments: Disclosure. Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as Deloitte Global ) does not provide services to clients. Please see for a more detailed description of DTTL and its member firms. Deloitte Touche Tohmatsu Limited is a private company limited by guarantee incorporated in England & Wales under company number , and its registered office is Hill House, 1 Little New Street, London, EC4a, 3TR, United Kingdom.

15 a definition to help management apply the concept in preparing financial statements in accordance with IFRS. IFRS definition 7 Materiality is defined in the Conceptual Framework for Financial Reporting ( the Conceptual Framework ) as: provides the following definition of materiality (there are similar definitions in IAS 1 Presentation of Financial Statements and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors): Information is material if omitting it or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature and magnitude, or both, of the items to which the information relates in the context of an individual entity s financial report. 3 8 The words could influence in the definition of materiality are clarified in IAS 1, which states that the assessment of materiality should take into account how users could reasonably be expected to be influenced in making economic decisions on the basis of financial statements. 4 9 Financial statements are a type of general purpose financial report that summarise for external parties financial information that is recorded internally by an entity. Applying the concept of materiality ensures that financial information that could reasonably be expected to influence decisions that users make on the basis of those financial statements is separately presented in the primary financial statements (sometimes referred to as presenting information on the face of a financial statement ) or separately disclosed in the accompanying notes The concept of materiality is also intended to be applied as a filter to ensure that the financial statements are an effective and understandable summary of the information contained in an entity s internal accounting records. If information in the financial statements is not summarised or aggregated in a clear and helpful manner, for example if an excessive amount of immaterial information is disclosed or material information is obscured or concealed, it makes the financial statements less understandable for users. 6 Pervasiveness 11 The concept of materiality is pervasive to the preparation of financial statements. Requirements in IFRS must be applied if their effect is material to the complete set of financial statements. Similarly a requirement in IFRS need not be applied if the effect of not applying it is not material. 3 See paragraph QC11 of the Conceptual Framework. However paragraph 2.11 of the Exposure Draft ED/2015/3 Conceptual Framework for Financial Reporting, proposes to modify this definition by including the word primary before the word user. There are similar definitions in IAS 1 Presentation of Financial Statements and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. 4 See paragraph 7 of IAS 1. 5 The term primary financial statements is expected to be defined as part of the Principles of Disclosure project. For the purposes of this [draft] Practice Statement, the primary financial statements comprise the financial statements excluding the notes. In other words, the primary statements consist of the statement of financial position, statement of comprehensive income, statement of changes in equity and statement of cash flows. 6 See paragraph 30A of IAS 1. Page 2

16 Judgement 12 When assessing whether information is material to the financial statements, management applies judgement to decide whether information could reasonably be expected to influence decisions that the users make on the basis of those financial statements. When applying such judgement, management should consider both the entity s specific circumstances and how the information will be used by users of the financial statements. An entity s circumstances change over time and so materiality is reassessed in each reporting period in the light of the entity s circumstances during that period. This assessment should include comparing the current year information with comparative information for prior periods to assess changes in the entity s activities or circumstances during the period. Xx Xx Decision framework Critical to the application of materiality is a focus on the users of a particular set of financial statements. Those responsible for preparing a set of financial statements will need to: (a) understand who their primary users are and the types of decisions they will use the financial report to help them make; (b) identify the information that is likely to be relevant to those users, and from this information set, work out what is material to them; and (c) present the information in a meaningful way that emphasises those matters that are likely to be of most interest to the primary users. Materiality assessments are made in the context of the financial statements as a whole. It is therefore important for a preparer to assess the set of financial statements once it has been assembled to detemine that it presents fairly the financial position, financial performance and cash flows of the entity. That review should help in identifying any matters that should be addressed, by adding, removing or emphasising information. Primary users of the financial statements and their decisions 13 The definition of materiality refers to decisions made by the users of general purpose financial reports. The Conceptual Framework identifies the primary users of general purpose financial reports as follows and states that they are the users to whom those reports are directed: OB5 OB10 Many existing and potential investors, lenders and other creditors who cannot require reporting entities to provide information directly to them and must rely on general purpose financial reports for much of the financial information they need. Consequently, they are the primary users to whom general purpose financial reports are directed. Although other parties, such as regulators and members of the public other than investors, lenders and other creditors, may also find general purpose financial reports useful but they are not primary users. 7 However, those reports are not primarily directed to these other groups. 14 Having identified the primary users of the entity s general purpose financial statements and other general purpose financial reports, management should consider the characteristics of those users, including their likely interests and what types of decisions they are making. This will then enable 7 See OB5 and OB 10 of the Conceptual Framework. Page 3

17 management to identify the information that the primary users could reasonably expect to receive and that could reasonably be expected to influence their decisions. Characteristics of the primary users of financial statements 15 A preparer is entitled to assume that The Conceptual Framework sets out basic attributes of the primary users of the financial statements: QC32 Financial reports are prepared for users who have a reasonable knowledge of business and economic activities, but not that they are financial reporting experts. Users are expected to seek the assistance of advisers to help them understand information about complex economic phenomena. Users are also expected to review and analyse the information diligently. 8 They will QC32 Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently. At times, even well-informed and diligent users may need to seek the aid of an adviser to understand information about complex economic phenomena. 16 Although management is entitled to assume that the primary users have a reasonable knowledge of business and economic activities, they cannot assume that the primary users are financial reporting experts. Furthermore, Management should focus on typical and rational users, rather than a single, atypical user that is behaving unreasonably or irrationally. 17 An entity may have several different types of primary users. For example, the entity s investors may include individuals holding different classes of shares, institutional investors, bond investors, employees with options to buy shares and/or other types of investors. Across the range of possible primary users there may be a broad range of information needs and some may have dissimilar information needs and expectations. For example, some information might be useful to some primary users, but not others. If an entity has many classes of primary users, the financial statements should present and disclose information so as to meet the common information needs of a broad range of those classes. 18 Management cannot reasonably be expected to meet all of the information needs of all of the entity s primary users. For example, a single investor might be particularly interested in detailed information about an entity s expenditure in a specific location because that investor may also have a business operating in that location, but such detailed information may be inconsequential for the other primary users. 19 Nevertheless, information would usually be expected to be material if it is relevant to either a range of primary users across different classes or to a significant class of primary user (for example a class with a large number of users). Decisions made by the primary users of financial statements 20 The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. 9 The Conceptual Framework provides a description of the decisions made by the primary users and their information needs. 8 See QC32 of the Conceptual Framework. 9 OB2, Conceptual Framework Page 4

18 X X Xx Investors in debt or equity instruments are assumed to use financial reports to help them assess expected returns from instruments, to support decisions on whether to buy, hold or sell instruments. Those returns are dependent on the prospects for future net cash inflows to an entity. Some primary users could be more interested in corporate governance information, because their main decisions relate to exercising their voting rights, rather than making buy, hold or sell decisions. Accordingly, some information about director remuneration, for example, might be material to how they will vote on that matter but not material to an assessment of the value of the entity. Examples ways to identify information potentially useful to the primary users Gather information about Considering information about users expectations, including how they think the entity should be managed (ie stewardship) gathered through discussions with users or from information that is publicly available; Considering what decisions management themselves would seek to make and what information they would want as users of financial information in similar situations;. (ie as if they were external users themselves and did not possess the internal knowledge held by management for example about key risks or key value drivers); Observeing users or market responses to information or requests for information, for example on particular transactions or disclosures issued by the entity, or responses by external parties such as analysts; and Observeing the types of information provided by entities operating in the same industry. However, while there are similarities between entities in the same industry, it does not mean that the same kind of information will necessarily be material. General purpose financial reports can provide only some of the information that existing and potential investors, lenders and other creditors need. OB2 OB3 The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit. Decisions by existing and potential investors about buying, selling or holding equity and debt instruments depend on the returns that they expect from an investment in those instruments, for example dividends, principal and interest payments or market price increases. Similarly, decisions by existing and potential lenders and other creditors about providing or settling loans and other forms of credit depend on the principal and interest payments or other returns that they expect. Investors, lenders and other creditors expectations about returns depend on their assessment of the amount, timing and uncertainty of (the prospects for) future net cash inflows to the entity. Consequently, existing and potential investors, lenders and other creditors need information to help them assess the prospects for future net cash inflows to an entity. Page 5

19 OB4 OB6 To assess an entity s prospects for future net cash inflows, existing and potential investors, lenders and other creditors need information about the resources of the entity, claims against the entity, and how efficiently and effectively the entity s management and governing board have discharged their responsibilities to use the entity s resources. Examples of such responsibilities include protecting the entity s resources from unfavourable effects of economic factors such as price and technological changes and ensuring that the entity complies with applicable laws, regulations and contractual provisions. Information about management s discharge of its responsibilities is also useful for decisions by existing investors, lenders and other creditors who have the right to vote on or otherwise influence management s actions. However, general purpose financial reports do not and cannot provide all of the information that existing and potential investors, lenders and other creditors need. Those users need to consider pertinent information from other sources, for example, general economic conditions and expectations, political events and political climate, and industry and company outlooks. 21 In developing Standards, the IASB seeks to identify the information that is expected to meet the needs of a broad range of primary users, for a wide variety of entities. Consequently, when management considers what information should be provided in the financial statements, the requirements in IFRS should provide the basis for that assessment. The requirements within IFRS have been developed by the IASB taking into consideration the balance between the benefits of providing information to users of the financial statements and the costs of complying with those requirements. Consequently, the cost of applying the requirements in IFRS is not a factor for management to consider when assessing whether information is material. However, it is not sufficient to apply the presentation and disclosure requirements in a Standard mechanically, without considering the entity s specific circumstances, whether the entity s primary users have any special needs and whether the information provided meets or exceeds the needs of an entity s primary users. 22 Some examples of ways in which management can identify whether information is or is not useful to the primary users include: 23 Financial information is capable of making a difference to decisions if it has predictive value, confirmatory value or both. 10 The focus of the materiality assessment is whether the information could reasonably be expected to influence decisions made by users rather than whether that piece of information alone is capable of changing their decisions. Information is material if it confirms trends that could reasonably be expected to reinforce decisions made by the primary users. For example, an entity s earnings may have increased in line with expectations and this information may reinforce a decision to buy, hold or sell shares in the entity. Quantitative and qualitative and quantitative assessment 24 The assessment of whether information is material depends on its size and nature, judged in the particular circumstances of the entity. 11 Consequently, applying materiality involves assessing qualitative and quantitative factors. Quantitative factors 10 See paragraph QC7 of the Conceptual Framework. 11 See paragraph 7 of IAS 1. Page 6

20 25 Quantitative information, such as an item s value or carrying amount, is not the only factor that is considered when assessing whether an item is material. The assessment of whether an item is material also depends on qualitative considerations, including entity-specific factors. Consequently, it would not be appropriate for an entity applying IFRS to rely on purely numerical guidelines. Similarly, it is not appropriate for IFRS to specify a uniform quantitative threshold for materiality or to predetermine what is material in a particular situation. 26 However, wwhile quantitative thresholds are not in themselves determinative, they can be a helpful tool in applying the concept of materiality. A quantitative threshold may provide the basis for a preliminary assessment that an amount is likely to be material or immaterial; for example if it is below a specified percentage of profit or net assets. However, a materiality assessment also requires consideration of the nature of the item and the entity s circumstances. Consequently, it would not be appropriate for an entity applying IFRS to rely on purely numerical guidelines. Xx Xx Xx Qualitative characteristics relate to the quality or nature of the matter being assessed, rather than the amounts involved such as for a receivable, the type, its terms, the type of counterparty, any security given by the counterparty, the currency it is denominated in and so on. The nature of the activity or item should inform management as to whether they should assign a higher or lower threshold in terms of the amounts involved. When it comes to assessing less usual items, IFRS already highlights some areas where the materiality threshold would be lower because of the nature of the information. IAS 24 Related Party Disclosure provides guidance for applying materiality. Its objective is to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances, including commitments, with such parties. 12 Hence, for special relationships the threshold to warrant separate disclosure may be lower than for other day-to-day transactions. IAS 1 gives examples of circumstances that could warrant the separate disclosure of items of income and expense, because they are unusual. These include write-downs, or reversals of write-downs of inventories or of property, plant and equipment; the effect of restructurings; disposals of items of property, plant and equipment or investments; discontinued operations; litigation settlements; and reversals of provisions. 13 For example, simply disclosing the existence of a legal claim against the entity, which might not even have been recognised as liability, without explaining the circumstances is unlikely to meet the requirements of IFRS. 27 Examples in which considering quantitative aspects may not be helpful when making assessments about materiality include: Examples qualitative factors In deciding whether a particular accounting policy should be disclosed, management considers whether its disclosure is necessary to understand the financial statements. A description of an accounting policy would be material by its nature if the primary users would be unable to understand the financial statements sufficiently for their decision-making purposes if it were not disclosed IAS 24, paragraph 1. IAS 1, paragraph 98. Page 7

21 Xx An example of an inadequate and potentially immaterial disclosure would be when an entity simply quotes the requirements within IFRS without tailoring the description of its accounting policy to explain how it has been applied by the entity. In considering the materiality of uncertainties and contingencies, the monetary amounts involved are not always known or may have a potentially wide range of outcomes. Consequently, when making judgements on whether information about these uncertainties and contingencies is material, management considers factors such as the nature of the items, their potential financial effect and timing of cash outflows. Accordingly, even if the outcome of a lawsuit is uncertain, information about that lawsuit is likely to be material if the consequences of an unfavourable finding would be significantly detrimental to the company. 14 If a fair value estimate of material assets recognised in the financial statements is particularly sensitive to assumptions about sales volumes, that assumption is likely to be material. If the economic benefits of land acquired for the purposes of expanding a production facility are dependent on the company being granted a change in permitted use of the land, this information is likely to be material if the land itself is material to the entity. For some matters, materiality considerations will be more sensitive because they relate to key statistics used by the primary users, or to targets communicated by management, or otherwise relate to areas of particular importance to the primary users. Examples Sensitive items Examples of items for which this may be the case include: Transactions that Those that could trigger non-compliance with regulatory requirements or loan covenants. Events that are likely to affect the cash flows of the entity in a future but foreseeable period, such as the successful outcome of an important drugs trial or the entity s involvement in an environmental accident. Those that could reasonably be expected to be key to the entity s future operations, even if they do not have a material effect on the primary financial statements in the current period. An example would be part of the entity s business that is currently relatively small but for which management are planning an expansion; or Rare or unusual transactions, for which the management s reasons ing for undertaking them transactions could reasonably be expected to influence decisions made by the 14 Key factors to consider can often be determined by looking at the IFRS disclosures for those items for example, see paragraph 85(b) of IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Page 8

22 primary users. For example, a transaction may be unusual because it was on special terms with a related party of the entity. Xx Specific balances There might also be circumstances when lower thresholds are applied to specific balances. This could be because of legal requirements or because of special circumstances that are relevant during the current period. Examples specific balances In some jurisdictions the financial report must include information about country-by-country tax payments. In many circumstances that requirement is absolute and is outside normal materiality decisions. A jurisdiction may have a general requirement for disclosure of information about business undertaken in specified countries, perhaps because of trade restrictions. Particular disclosures in relation to an industry in which the entity operates may be important, such as research and development costs in a technology company. Individual and collective assessment 29 The assessment of whether information is material or immaterial should be undertaken on both an individual and a collective basis. 15 Even if information is judged not to be material in isolation (ie it is considered immaterial), it might be material when considered together with other information (for example see paragraph 39(c)). Xx Xx The assessment will need to include how the matter affects performance metrics that are important to the primary users. It could be that EBIT or EBITDA are particularly important in some sectors, and this could be a factor to consider. In a similar manner, for an entity in a start-up phase revenue might be more important than net income. An item that is reported in other comprehensive income (OCI) should not be considered to be less important than items reported in profit or loss solely because of that fact. Whether the specific information is material will depend on how it affects the financial statements as a whole. Presentation and disclosure in the financial statements The context of the materiality assessment 30 The primary objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Judgements on whether information is material should be made within the context of this objective and by considering the complete set of financial statements (ie the primary financial 15 See paragraph 7 of IAS 1. Page 9

23 statements together with the notes). Financial statements also show the results of the management s stewardship of the resources entrusted to it Applying the concept of materiality when preparing the financial statements requires judgement to be applied in the light of the objective of the financial statements. Management should use judgement not only to decide whether to include or exclude information in the financial statements, but also in considering how information should be presented or disclosed in those financial statements. 32 Management should also assess whether information is material within the context of the different parts of the financial statements; for example: (a) (b) (c) whether and how information should be presented separately in the primary financial statements; whether and how information should be included in the notes; and whether the assessment in paragraph 32(a) or (b) changes after reviewing the complete set of financial statements. 33 The last step in paragraph 32(c) would include an assessment of the overall mix of information in the financial statements. This overall assessment could lead to a reassessment of how information is presented or disclosed in order to make it more understandable or give it increased prominence. The overall assessment may also identify that some information should be supplemented (for example to highlight key trends) or be removed (for example if it is sufficiently covered by other information). Immaterial information 34 Providing immaterial information in the financial statements may obscure material information. and consequently mean that the financial statements are less understandable. For example, if an entity discloses detailed information about transactions that do not have a material effect on the entity s reported financial position or financial performance this may make the material information harder to find. Disclosing immaterial information increases the length of financial statements, makes them less understandable and requires the primary users to spend more resources in searching for material information. 35 IFRS does not prohibit entities from disclosing immaterial information. Nevertheless, it requires them to consider whether disclosure of immaterial information results in material information being obscured In some cases it might be helpful to disclose the fact that a particular issue is immaterial to the entity. For example, management may wish to inform the primary users that the entity is not exposed to a particular risk normally associated with an item that is of particular interest to market participants. This could be achieved an often be done by making a simple statement rather than including detailed information or analysis about the amount or nature of the item. For example, an international bank may explain that it does not hold a material amount of debt in a particular jurisdiction or industry that is 16 See paragraphs 9 of IAS 1 and paragraph OB2 of the Conceptual Framework. Note: paragraph 3.4 of the Exposure Draft Conceptual Framework for Financial Reporting is proposing to modify the description of the objective of financial statements (and includes an explicit discussion of stewardship considerations) as follows: The objective of financial statements is to provide information about an entity s assets, liabilities, equity, income and expenses that is useful to users of financial statements in assessing the prospects for future net cash inflows to the entity and in assessing management s stewardship of the entity s resources. 17 See paragraphs 30A and BC30F of IAS 1. Page 10

24 Xx suffering severe financial difficulties, without providing further information. In this case, the statement that the entity is holding an immaterial amount of debt may provide material information about how effective management has been in protecting the entity s resources from unfavourable effects of economic conditions. Focusing on information that is specific to the business can help filter out boiler-plate, generic, disclosures which can also reduce clutter. For example, the accounting policy information presented in the financial statements should focus on how the policies are relevant to the business and how management has applied them. Primary financial statements versus the notes Primary financial statements 40 The primary financial statements provide a structured summary of the entity s: (a) recognised assets, liabilities, equity, income and expenses; (b) cash flows; and (c) contributions from, or distributions to, holders of equity claims. 41 The role of the primary financial statements in meeting the objective of financial statements is to provide information that gives an overview of the financial position and performance of an entity. Such an overview may be useful for the primary users as follows: (a) obtaining essential information about the entity s assets, liabilities, equity, income, expenses, cash flows and contributions and distributions from/to holders of equity claims; (b) understanding the past financial position and performance of the entity in order to forecast net cash inflows and to understand trends; (c) making high-level comparisons between entities and reporting periods; and/or (d) identifying areas of particular interest for which the user could expect to find additional information in the notes When assessing which line items should be presented on the face of a primary financial statement, management considers how to provide a representative summary of the financial information of the entity for example, it considers which items or classes of items should be presented separately because of their relative size or their nature. Management should also consider the degree of similarity or difference between individual line items when determining whether those items should be combined or presented separately. 43 Management considers The materiality of an item is assessed Whether an item is material by considering it relative to individual line items, subtotals and totals on the face of an individual statement, as well as to each overall individual statement. Consideration should also be given to Management should also consider the relationships between each of the primary financial statements, including assessing. When presenting line items, management should assess which items serve as useful signposts to link the face of the statements with the detail in the notes to help the primary users navigate through the financial statements. 18 The guidance in paragraphs 41, 45 and 47 is drafted in line with the IASB s initial thinking during its Principles of Disclosure project see paragraph BC21 of the Basis for Conclusions on this [draft] Practice Statement. Page 11

25 44 If recognised items are not presented separately in the primary financial statements, then management consideration should be given to how they should be aggregated with other items (see paragraphs 37 39). Notes 45 Because of their structure, the amount and type of detail that can be included in the primary financial statements is limited. The notes: (a) (b) explain the information presented in the primary financial statements in greater detail; and supplement the primary financial statements with additional information that is necessary to meet the objective of financial statements (see paragraph 30) Although the concept of materiality does not change when applied to the notes, the context in which that concept is applied is different. This is because the notes have a different role from the primary financial statements in meeting the objective of financial statements (see paragraphs 40 44). Consequently, this may result in different conclusions regarding whether information is material in the different contexts and whether further disaggregation in the notes is necessary compared to the face of a primary financial statement. 47 One of the main objectives of the notes, as an integral part of the financial statements, is to amplify and explain the items in the primary financial statements. Information that is material to the financial statements, but for which separate presentation in the primary financial statements is not material, is provided in the notes. Nevertheless, if information is material in the context of the primary financial statements then disclosure in the notes is not sufficient. For example, management may decide to present only a single amount for total revenue on the face of the statement of comprehensive income. In the notes management should disaggregate the amount and disclose further information, as appropriate, to enable the primary users to understand the nature, amount, timing and uncertainty of the revenue and related cash flows In addition to amplifying and explaining the items in the primary financial statements, the notes also provide any other financial information that is necessary to meet the objective of financial statements (see paragraph 30) and could reasonably be expected to influence decisions of the primary users. Some information typically found in note disclosures does not relate to line items in the primary financial statements; such as material non-adjusting events after the balance sheet date. Furthermore, some information relates to items that are not recognised, such as contingent liabilities. xx Aggregating and disaggregating information Financial statements result from processing large numbers of transactions or other events that are aggregated into classes according to their nature or function. The final stage in the process of aggregation and classification is the presentation of condensed and classified data, which form line items in the financial statements. If a line item is not individually material, it is aggregated with other items either in those statements or in the notes. The primary financial statements should present 19 The guidance in paragraphs 41, 45 and 47 is drafted in line with the IASB s initial thinking during its Principles of Disclosure project see paragraph BC21 of this [draft] Practice Statement. 20 The guidance in paragraphs 41, 45 and 47 is drafted in line with the IASB s initial thinking during its Principles of Disclosure project see paragraph BC21 of this [draft] Practice Statement. Page 12

26 X X separately each material class of similar items so that items that are dissimilar by nature or function are not aggregated, unless those items are immaterial. The financial statements will become less understandable if individually material items are aggregated with other items that have a different nature or function. An item that is not sufficiently material to warrant separate presentation in the primary financial statements may warrant separate presentation in the notes. This principle on aggregation also applies to the notes An entity shall present separately each material class of similar items. An entity shall present separately items of a dissimilar nature or function unless they are immaterial. 30 Financial statements result from processing large numbers of transactions or other events that are aggregated into classes according to their nature or function. The final stage in the process of aggregation and classification is the presentation of condensed and classified data, which form line items in the financial statements. If a line item is not individually material, it is aggregated with other items either in those statements or in the notes. An item that is not sufficiently material to warrant separate presentation in those statements may warrant separate presentation in the notes. 30A When applying this and other IFRSs an entity shall decide, taking into consideration all relevant facts and circumstances, how it aggregates information in the financial statements, which include the notes. An entity shall not reduce the understandability of its financial statements by obscuring material information with immaterial information or by aggregating material items that have different natures or functions. 38 If a line item in the primary financial statements is not individually material, it does not need to be disaggregated further, and it can be aggregated with other related or similar items even if IFRS prescribes separate presentation. However, an item that is not material in the primary financial statements may warrant separate presentation in the notes. For example, management may decide to combine all of its financial assets that are measured at fair value through profit or loss together in one line item on the face of the statement of financial position, if separate presentation is not considered material within the context of the primary financial statements. However, management should also consider whether separate presentation of different classes of financial assets is material within the context of the notes because of the different characteristics of those financial assets. For example, there may be different types of financial assets (such as equity or debt instruments) or assets may have different risk characteristics. Nevertheless, line items in the primary financial statements are disaggregated in the notes only if information about their components is material. If, for example, the components of the line item are similar and there is no single significant component, disaggregation in the notes may not provide useful information. 39 Aggregating information means that information about the components becomes less detailed. Hence, when making judgements about whether to aggregate information, either in the primary financial statements or in the notes, requires management is an assessment of ing whether the material information that would be lost through aggregation. is material. For example: 21 See IAS A. Page 13

27 Examples aggregation and separate presentation or disclosure If an entity has 500 many similar leases of similar assets, then combining them together for disclosure purposes is unlikely to may not lead to a loss of material information. However, if a subset of those 500 leases has significantly different characteristics from the others (such as residual value guarantees or extension options), separate information about that subset may be material. An entity may have a small net foreign exchange difference as a result of transactions in foreign currencies. That net difference might have arisen from a large number of small exchange gains on a broad base of recurring transactions and a substantial loss that resulted from one speculative forward foreign exchange transaction. IAS 21 The Effects of Changes in Foreign Exchange Rates specifies only that the amount of exchange differences is disclosed. When making judgements about materiality, the entity should assess whether the loss should be reported separately from the other exchange differences. The fact that a large loss was incurred relative to the other transactions, and that the loss was from speculative activity, suggests that aggregating these exchange differences would result in a loss of material information. In this scenario, information that could influence users opinions of management s stewardship would be lost through aggregation. An entity might acquire many small businesses during the reporting period. Each acquisition might be individually immaterial, but in aggregate the acquisitions could change the structure and prospects of the business in a material way. Because it is the aggregated effect of the business combinations that is material, it may be appropriate to include information about the acquisitions in aggregate. Primary financial statements versus the notes Primary financial statements 40 The primary financial statements provide a structured summary of the entity s: (d) recognised assets, liabilities, equity, income and expenses; (e) cash flows; and (f) contributions from, or distributions to, holders of equity claims. 41 The role of the primary financial statements in meeting the objective of financial statements is to provide information that gives an overview of the financial position and performance of an entity. Such an overview may be useful for the primary users as follows: (e) obtaining essential information about the entity s assets, liabilities, equity, income, expenses, cash flows and contributions and distributions from/to holders of equity claims; Page 14

28 (f) understanding the past financial position and performance of the entity in order to forecast net cash inflows and to understand trends; (g) making high-level comparisons between entities and reporting periods; and/or (h) identifying areas of particular interest for which the user could expect to find additional information in the notes When assessing which line items should be presented on the face of a primary financial statement, management considers how to provide a representative summary of the financial information of the entity for example, it considers which items or classes of items should be presented separately because of their relative size or their nature. Management should also consider the degree of similarity or difference between individual line items when determining whether those items should be combined or presented separately. 43 Management considers whether an item is material by considering it relative to individual line items, subtotals and totals on the face of an individual statement, as well as to each overall individual statement. Management should also consider the relationships between each of the primary financial statements. When presenting line items, management should assess which items serve as useful signposts to link the face of the statements with the detail in the notes to help the primary users navigate through the financial statements. 44 If recognised items are not presented separately in the primary financial statements, then management considers how they should be aggregated with other items (see paragraphs 37 39). Notes 45 Because of their structure, the amount and type of detail that can be included in the primary financial statements is limited. The notes: (c) (d) explain the information presented in the primary financial statements in greater detail; and supplement the primary financial statements with additional information that is necessary to meet the objective of financial statements (see paragraph 30) Although the concept of materiality does not change when applied to the notes, the context in which that concept is applied is different. This is because the notes have a different role from the primary financial statements in meeting the objective of financial statements (see paragraphs 40 44). Consequently, this may result in different conclusions regarding whether information is material in the different contexts and whether further disaggregation in the notes is necessary compared to the face of a primary financial statement. 47 One of the main objectives of the notes, as an integral part of the financial statements, is to amplify and explain the items in the primary financial statements. Information that is material to the financial statements, but for which separate presentation in the primary financial statements is not material, is provided in the notes. Nevertheless, if information is material in the context of the primary financial statements then disclosure in the notes is not sufficient. For example, management may decide to 22 The guidance in paragraphs 41, 45 and 47 is drafted in line with the IASB s initial thinking during its Principles of Disclosure project see paragraph BC21 of the Basis for Conclusions on this [draft] Practice Statement. 23 The guidance in paragraphs 41, 45 and 47 is drafted in line with the IASB s initial thinking during its Principles of Disclosure project see paragraph BC21 of this [draft] Practice Statement. Page 15

29 present only a single amount for total revenue on the face of the statement of comprehensive income. In the notes management should disaggregate the amount and disclose further information, as appropriate, to enable the primary users to understand the nature, amount, timing and uncertainty of the revenue and related cash flows In addition to amplifying and explaining the items in the primary financial statements, the notes also provide any other financial information that is necessary to meet the objective of financial statements (see paragraph 30) and could reasonably be expected to influence decisions of the primary users. Some information typically found in note disclosures does not relate to line items in the primary financial statements; such as material non-adjusting events after the balance sheet date. Furthermore, some information relates to items that are not recognised, such as contingent liabilities. Disclosures specified in IFRS 49 IAS 1 states: 31 Some IFRSs specify information that is required to be included in the financial statements, which include the notes. An entity need not provide a specific disclosure required by an IFRS if the information resulting from that disclosure is not material. This is the case even if the IFRS contains a list of specific requirements or describes them as minimum requirements. An entity shall also consider whether to provide additional disclosures when compliance with the specific requirements in IFRS is insufficient to enable users of financial statements to understand the impact of particular transactions, other events and conditions on the entity s financial position and financial performance. 50 The disclosure requirements in IFRS are the basis for management to decide what information should or should not be disclosed in the notes. When a Standard contains a disclosure requirement and the related information to satisfy that requirement is material, then management should disclose that information in line with the IFRS requirement. However, this does not mean that IFRS disclosure requirements should be treated as a checklist, without regard to the entity s circumstances and the needs of its primary users. Management is not required to provide disclosures in the level of detail specified by a Standard, or even provide them at all, if the related information is not material, because immaterial information does not need to be disclosed When Standards contain disclosure objectives, management should make an overall assessment of whether it has satisfied those objectives for material information. This includes considering: (a) (b) whether financial statements provide all the specified disclosure requirements related to an objective; and whether information in addition to that specified in the Standards should be disclosed to meet those objectives and help users understand the information provided. 52 An entity must also provide information in addition to the information specified in IFRS if that information is relevant to an understanding of the financial statements and could reasonably be expected to influence decisions that the primary users make on the basis of the financial statements. 24 The guidance in paragraphs 41, 45 and 47 is drafted in line with the IASB s initial thinking during its Principles of Disclosure project see paragraph BC21 of this [draft] Practice Statement. 25 See IAS 1.31 Page 16

30 Examples IAS 16 Property, Plant and Equipment An entity that does not have material contractual commitments for the acquisition of property, plant and equipment need not disclose immaterial commitments. If an entity has several large employee benefit plans and some smaller plans, it may be sufficient to disclose only the key risks and sensitivities for the smaller plans, rather than all of the detailed items set out in IAS 19 Employee Benefits. If share-based payments are material to the financial statements, the entity considers which information required by paragraphs of IFRS 2 Share-based Payments is useful to the primary users and also whether any additional information should be disclosed. In some cases, instead of disclosing all the information in paragraphs of IFRS 2, it might be appropriate to summarise some information, such as providing a range of vesting periods, if that does not lead to the loss of material information. IFRS 8 Operating Segments requires disclosure of information that might be recognised and measured on a different basis than IFRS (even though IFRS 8 requires the segment information to be reconciled to corresponding IFRS figures in the entity s financial statements). Nevertheless the concept of materiality should still be applied by management in deciding what information to include in the financial statements about an entity s operating segments. IFRS 8 provides criteria that management should consider as part of its materiality judgements, including segment aggregation criteria, and quantitative thresholds for segments. IFRS 12 Disclosure of Interests in Other Entities specifies information that must be disclosed in relation to each subsidiary with material non-controlling interests. In considering whether a non-controlling interest is material it would be appropriate to consider the size of the NCI relative to other components of equity as well as the assets and liabilities in the affected subsidiary relative to the assets and liabilities of the group. 53 For example: (a) IAS 16 Property, Plant and Equipment prescribes specific disclosure requirements for property, plant and equipment. However, even if property, plant and equipment is presented as a separate line item in the statement of financial position, not all disclosures specified in IAS 16 will automatically be material for an entity. For example, if the amount of contractual commitments for the acquisition of property, plant and equipment is not material, such disclosure is not required. Furthermore, management should provide other information about property plant and equipment, even if not specifically required by IFRS, if that information could Page 17

31 reasonably be expected to influence decisions that the primary users make on the basis of the financial statements. (b) IAS 19 Employee Benefits prescribes detailed disclosure requirements about the amount, timing and uncertainty of future cash flows for defined benefit plans (paragraphs of IAS 19), including a sensitivity analysis. However, if an entity has several large plans and some smaller plans, then for the smaller plans, it may be sufficient to disclose only the key risks and sensitivities. (c) IFRS 2 Share-based Payments prescribes detailed disclosure requirements for an entity that has share-based payment transactions. If share-based payments are material to the financial statements, the entity considers which information required by paragraphs of IFRS 2 is useful to the primary users and also whether any additional information should be disclosed. In some cases, instead of disclosing all the information in paragraphs of IFRS 2, it might be appropriate to summarise some information, such as providing a range of vesting periods, if that does not lead to the loss of material information. (d) (d) IFRS 8 Operating Segments requires disclosure of information that might be recognised and measured on a different basis than IFRS (even though IFRS 8 requires the segment information to be reconciled to corresponding IFRS figures in the entity s financial statements). Nevertheless the concept of materiality should still be applied by management in deciding what information to include in the financial statements about an entity s operating segments. IFRS 8 also provides additional criteria that management should consider as part of its materiality judgements, including segment aggregation criteria, and quantitative thresholds for segments. Reviewing note disclosures at each reporting date 54 If a disclosure was material to the prior period s financial statements, but the same level of detail or type of information is not material to the current-year financial statements, the full comparative information might not need disclosure often does not need to be repeated. in the same level of detail. The information could be summarised or in some cases omitted altogether provided that material information, for example, information needed to identify key financial trends, is not lost. For example: Examples comparative information It might be appropriate to summarise a previous business combination rather than reproduce all of the detail provided in the prior period s financial statements. A detailed reconciliation of property, plant and equipment may have been included in the prior year financial statements because of changes that took place in that period. In the current period it might be appropriate to aggregate some of the comparative information. If an impairment loss was recorded for an item of plant or machinery in the prior year, but not in the current year, then detailed disclosures about the measurement basis, such as the fair Page 18

32 (a) (b) (c) value hierarchy and techniques might not be material in the current year. if in the prior period the entity undertook a significant business combination, management would consider what information is important to an understanding of the current period financial statements. This might lead management to conclude that it should not reproduce all of the detail about the business combination provided in the prior period s financial statements. However, management should still provide sufficient information for comparisons to be made between years and to the extent that the information is relevant to understanding the current period financial statements, including the comparative information. a detailed reconciliation of property, plant and equipment may have been included in the prior year financial statements because of changes that took place in that period. However, it might not be necessary to include such a detailed reconciliation in the current period if there have been limited changes in the current year. For example, it may be appropriate to aggregate some of the information that was presented separately in the prior year reconciliation when preparing comparative information for the current period financial statements. if an impairment loss was recorded for an item of plant or machinery in the prior year, but not in the current year, then detailed impairment disclosures may not be material in the current year. 55 Nevertheless, materiality is not assessed only by reference to the current reporting date. For example: Xx It may be that changes related to prior periods rather than the absolute quantitative amount in the current period that is material. Examples Changes from prior periods Information about a prior year business combination that took place in a prior period might be material in the current period if it enables the primary users to understand the effect of the prior year business combination on the entity s performance for the current reporting period such as. For example, an acquirer discloses information that enables the primary users of its financial statements to evaluate any material the effects of adjustments or contingent consideration settlements recognised in the current reporting period. that relate to business combinations in previous reporting periods. A fall in sales of a major product from a material amount in the prior year to an immaterial amount in the current year may be a material change that should be separately disclosed or identified in the current year. Complete set of financial statements 56 IAS 1 requires an assessment of whether information is material individually and collectively. (see paragraph 29). Consequently, the assessment of whether an individual piece of information is material in the financial statements is not made in isolation. This assessment should also consider whether the information is material in combination with other information in the complete set of financial Page 19

33 statements. This wider perspective enables management to consideration of the overall picture of the entity s financial position, financial performance and cash flows, including information about financial trends. It also enables an overall assessment of whether information in the financial statements is communicated in an effective and understandable way. For example management should consideration should be given to whether matters of particular importance have been given sufficient prominence and whether related information is presented in such a way that the linkage is clear. 57 The primary users of financial statements consider information in a wider context than the financial statements. For example, they also consider other sections of the financial report, information about the industry that the entity operates in and its competitors, and about the economy in general. Consequently, the assessment of whether and how information should be disclosed in the financial statements may depend on the availability of other information from publicly accessible sources. Nevertheless, public availability of information does not relieve the entity of the obligation to disclose information that is specifically required by IFRS in the financial statements if that information is material. 58 The financial statements are intended to be a comprehensive document that provides information about the financial position, financial performance and cash flows of an entity that is useful to the primary users in making decisions. Consequently it would not be appropriate to omit information that is specifically required by IFRS about the entity from the financial statements solely because it had previously been included in a press release or other publicly available document. Information incorporated by reference would be considered to be part of the financial statements. Xx Xx Xx Presentation and emphasis How information is presented is part of the materiality assessment, because presentation can affect its usefulness, and how it is perceived by the primary users. In other words, presentation matters if it can influence or affect the decisions taken by the primary users. It is not sufficient to argue that the information was included in the report, if it is difficult to find. Nor is it appropriate if information that should be considered together, to provide a more complete picture of an aspect of the business, is presented as if it is not related. Providing more emphasis to some aspects of a transaction while deemphasising other aspects can undermine neutrality. Part of the materiality decision involves identifying which matters should be given particular emphasis and which matters should be presented together, or at least related to each other by way of crossreference. Among the factors that should be considered are: (a) Is the tone of the language used appropriate to the issue being conveyed? For example, a dismissive tone when discussing possible litigation against the entity when the litigant has reasonable grounds would not be appropriate. (b) Are matters of particular importance give sufficient prominence? (c) Is the information formatted in a way that communicates effectively? For example, data intensive disclosures such as maturity analysis or reconciliations are generally clearer when presented in a table. (d) Are there any notes which have superfluous information that obscures the material information, such as generic statements that do not help the reader understand the particular circumstances of the entity? Page 20

34 Interim reporting 59 Materiality is a pervasive concept in IFRS. The same general principles on the application of materiality to the annual financial statements also apply to interim financial statements. However, the context and objectives in which the concept is applied are different. This is because the objective of interim financial statements is different from the objective of annual financial statements. In particular, interim financial statements are intended to provide an update on the latest complete set of annual statements. Accordingly, interim financial statements focus on new activities, events, and circumstances and do not duplicate information previously reported Furthermore, even though IAS 34 Interim Financial Reporting regards interim financial statements as an update of the latest annual financial statements, IAS 34 specifies that materiality for interim financial statements is assessed in relation to the interim period financial data, not forecast annual data. 27 IAS 34 provides the following guidance on the assessment of materiality for interim financial statements: 23 In deciding how to recognise, measure, classify, or disclose an item for interim financial reporting purposes, materiality shall be assessed in relation to the interim period financial data. In making assessments of materiality, it shall be recognised that interim measurement may rely on estimates to a greater extent than measurements of annual financial data. 25 While judgement is always required in assessing materiality, this Standard bases the recognition and disclosure decision on data for the interim period by itself for reasons of understandability of the interim figures. Thus, for example, unusual items, changes in accounting policies or estimates, and errors are recognised and disclosed on the basis of materiality in relation to interim period data to avoid misleading inferences that might result from non-disclosure. The over-riding goal is to ensure that an interim financial report includes all information that is relevant to understanding an entity s financial position and performance during the interim period. Recognition and measurement 61 Much of the content of this [draft] Practice Statement focusses on providing guidance on the application of materiality when presenting and disclosing information in the financial statements. However, similar considerations also apply to the recognition and measurement of the information that is provided in the financial statements. 62 IFRS recognition and measurement requirements are applied if their effect is material to the financial statements. In particular, IAS 8 states that financial statements do not comply with IFRS if they contain either material errors or immaterial errors made intentionally to achieve a particular presentation of an entity s financial position, financial performance or cash flows. 28 [Note: this is covered in a subsequent section, so is not required here] Practical expedients Recording procedures 63 IFRS does not specify requirements for an entity s internal record keeping procedures. Consequently, management might decide not to apply a requirement in a Standard when it records a particular item, 26 See paragraph 6 of IAS See paragraph IN9 of IAS See paragraph 41 of IAS 8. Page 21

35 provided it later makes an adjustment to ensure the information is in accordance with IFRS for financial reporting purposes. For example, an entity might maintain a periodic inventory system and then later adjust amounts for the purchases and inventory for financial reporting purposes based on physical stock counts. 66 Provided information is fairly presented in accordance with IFRS in the financial statements, it is beyond the scope of IFRS to specify how that information is recorded internally. Nevertheless, there may be legal requirements in an entity s jurisdiction that prescribe requirements for an entity s internal record-keeping procedures. Recognition expedients 64 An entity might have an internal policy of capitalising capital expenditures only in excess of a specified threshold and recognising smaller amounts as an expense., because any smaller amounts are considered to be clearly immaterial. Management has assessed that this departure from IFRS is unlikely to will not have a material effect both on the current financial statements or and in future financial statements, because it is clear such expenditure is not material, and a different accounting treatment to that required by an IFRS could not reasonably be expected to influence decisions made by the primary users. Provided that such a practice does not have a material effect on the financial statements, it would not prevent the entity s financial statements from complying with IFRS (see also paragraphs 77 79). Such a policy should nevertheless be reassessed periodically to ensure that these assumptions remain appropriate. Provided that such a practice does not have a material effect on the financial statements, it would not prevent the entity s financial statements from complying with IFRS (see also paragraphs 77 79). 65 It is also conventional for entities to select a monetary unit, for example CU1,000,and to report rounded information, such as to the nearest thousand or million, to the nearest unit when preparing the financial statements. The chosen unit is set sufficiently low to ensure that the resulting loss of precision and detail is immaterial Provided information is fairly presented in accordance with IFRS in the financial statements, it is beyond the scope of IFRS to specify how that information is recorded internally. Nevertheless, there may be legal requirements in an entity s jurisdiction that prescribe requirements for an entity s internal record-keeping procedures. Omissions and misstatements ( misstatements ) Identified misstatements 67 Omissions (ie excluding relevant data/information), errors and other misstatements of information (eg describing information ambiguously or obscuring material information) (collectively referred to as misstatements in this document) are material if, individually or collectively, they could reasonably be expected to influence decisions that the primary users make on the basis of the financial statements. Management should assess whether misstatements of information are material to the financial statements. This assessment includes considering any misstatements in the comparative information included in respect of prior periods. 68 Errors are a type of misstatement in the entity s financial statements arising from a failure to use, or misuse of, reliable information that: 29 In this [draft] Practice Statement, currency amounts are denominated in currency units (CU). Page 22

36 (a) was available when financial statements for those periods were authorised for issue; and/or (b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.30 Such errors include the effects of arithmetical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud (such as an employee misappropriating funds). 69 In assessing whether misstatements are material, management should take into account how precisely transactions can be measured. For example most cash disbursements or cash sales are capable of precise measurement and so misstatement of these transactions would not be expected to occur frequently if an entity has effective internal controls. For other transactions, precise measurement will not be possible and management is required to make estimates; for example provisions for expected environmental clean-up costs 23 or Level 3 fair value measurements. 31,32 Because of the uncertainty inherent in estimates, it may be more difficult to assess misstatements in these situations. Consequently, the disclosures in the financial statements should ensure that the primary users are made aware of the subjectivity involved in recognising and measuring such items. When considering whether an adjustment should be treated as a change in estimate or the correction of an error management should be guided by the requirements in IAS 8. Current period misstatements 70 Two common examples of situations in which management may identify that it has misstated information in the entity s financial statements are: (a) (b) in preparing the financial statements, management might identify bookkeeping errors are identified. Examples could include a mathematical error in an adjusting journal entry, or a double counting or omission of a physical inventory count. after the preliminary announcement of financial information and/or after the financial statements have been prepared but not yet authorised for issue, additional relevant information could be identified. 71 Management should amend t The financial statements should be amended for all material misstatements identified before they entity s financial statements are authorised for final issue, regardless of the cost of doing so. 33 Furthermore, it would be considered good practice to that management corrects all misstatements, even those that are not material. However, in some circumstances correcting an immaterial misstatement may be unduly costly or delay publication of an entity s financial statements. In such a case, an evaluation management should be made of evaluate all identified misstatements to consider whether, in relation to individual line items, subtotals, or totals in the financial statements, failure to address those misstatements could result in a material misstatement and hence result in noncompliance with IFRS. This requires consideration of the pervasiveness of the misstatements in the financial statements (eg whether they affect numerous line items). For example, an error recorded on a 30 Derived from the definition of a prior period error in paragraph 5 of IAS See measurement guidance in IAS See measurement guidance in IFRS 13 Fair Value Measurement. 33 See IAS 10 Events after the Reporting Period for the requirements about the date when the financial instruments are authorised for issue. Page 23

37 purchase of inventories will affect other balances such as trade payables, cost of sales and closing inventory. 72 IAS 1 requires an assessment of whether information is material individually and collectively. Consequently, management first considers whether each misstatement is material, irrespective of its effect when combined with other misstatements. If the misstatement causes the financial statements to be materially misstated, that effect cannot be offset by other misstatements. For example, if an entity s investment income is material within the context of the financial statements and it is materially overstated, the financial statements will be materially misstated even if the effect on profit is completely offset by an equivalent overstatement of expenses. 73 Consideration is then given to Management then considers whether the any misstatements are collectively material. on a collective basis. Even if a misstatement is judged not to be material on its own, it might be material when considered with other information. Prior period errors 74 Prior period errors are errors in the entity s financial statements for one or more prior periods. Paragraph 42 of IAS 8 requires that such error be corrected retrospectively in the first set of financial statements authorised for issue after the error is discovered. 34 states... an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue Errors in a prior period are sometimes not discovered until the current period. Any material prior period errors are corrected retrospectively by amending the comparative information presented in the financial statements unless it is impracticable to determine either the period specific effects or the cumulative effect of the error Management will also need to consider the effects in the current period of immaterial prior period errors if it is possible that those errors could cause the current period financial statements to be materially misstated. Because the error relates to information in the prior year, it may be less likely to influence materiality decisions than a similar misstatement in the current year, because the passage of time may make such information less relevant. Xxx Errors made in one period can affect future periods. The effect of errors made in a previous period, and that were identified at the time, therefore need to be considered in the current period. It could be that the natural reversing on the errors in combination with other matters from the current period results in a material misstatement of information in the current period financial statements. Misstatements made with the intention of to misleading 77 Paragraph 41 of IAS 8 states:... Financial statements do not comply with IFRSs if they contain either material errors or immaterial errors made intentionally to achieve a particular presentation of an entity s financial position, financial performance or cash flows Sometimes a deliberate decision is made by management not to apply a requirement in a Standard because management has concluded that the effect of not applying that requirement will not lead to a material difference in the financial statements (for an example, see paragraph 64). Unless management 34 IAS 8, paragraph See paragraph 43 of IAS 1. Page 24

38 has intentionally misstated items to achieve a particular presentation or result, such practical expedients would not prevent the financial statements from complying with IFRS. 79 However, If management intentionally misstates items to achieve a particular presentation or result it does so knowing that the financial statements will be misleading. That intention to mislead makes the misstatement material and the financial statements will not comply with IFRS. 36 it has does ne so presumably because it thinks that the particular presentation or result could reasonably be expected to influence the decisions of the primary users of the financial statements and such misstatements are material. That intent also differentiates it from a decision not to apply a requirement in a Standard because management has concluded that the effect will not lead to a material difference in the financial statements (for an example, see paragraph 64). Unless management has intentionally misstated items to achieve a particular presentation or result, such practical expedients would not prevent the financial statements from complying with IFRS. For example there is a difference between: Xx Xx Xx (a) (b) management deciding not to discount a liability to reflect the time value of money because there is no material difference between the discounted and non-discounted value, and management deliberately choosing to use an inappropriate discount rate to in order to reduce the amount of the liability. In the second case management is intentionally understating the amount of a liability with the intention of misleading the users of the financial statements. That intent makes it material. A deliberate choice by management to use an inappropriate discount rate would be material because management is presumably doing so in order to achieve a particular presentation of an entity s financial position, financial performance or cash flows. If management intentionally misstates items to achieve a particular presentation or result it does so knowing that the financial statements will be misleading. That intention to mislead makes the misstatement material and the financial statements will not comply with IFRS. In contrast, deciding not to apply a requirement in an IFRS or deciding not to correct the financial statements for trivial errors does not make those matters material, if management has concluded that the effect will not lead to a material difference in the financial statements. For example there is a difference between management deciding not to discount a liability to reflect the time value of money when there is no material difference between the discounted and non-discounted value and management deliberately choosing to use an inappropriate discount rate in order to reduce the amount of the liability with an intention of misleading the users of the financial statements. Review of the financial statements Xx Materiality judgements involve assessing whether more or less information about particular matters should be included in the set of financial statements report to make it fair, balanced and understandable. Reviewing the financial statements before they are authorised for issue provides those responsible for preparing them with the opportunity to consider whether: (a) any information that could be removed, or summarised further, to make sure the information known to be important to the primary users is more accessible; (b) there are gaps in the information that need to be remedied; 36 See paragraph 41 of IAS 8. Page 25

39 (c) the report is structured in a way that gives appropriate emphasis to the matters they know were important to the entity during the period and (d) the tone and language are balanced. Interim reporting 59 Materiality is a pervasive concept in IFRS. The same general principles on the application of materiality to the annual financial statements also apply to interim financial statements. However, the context and objectives in which the concept is applied are different. This is because the objective of interim financial statements is different from the objective of annual financial statements. In particular, interim financial statements are intended to provide an update on the latest complete set of annual statements. Accordingly, interim financial statements focus on new activities, events, and circumstances and do not duplicate information previously reported Furthermore, even though IAS 34 Interim Financial Reporting regards interim financial statements as an update of the latest annual financial statements, IAS 34 specifies that materiality for interim financial statements is assessed in relation to the interim period financial data, not forecast annual data In deciding how to recognise, measure, classify, or disclose an item for interim financial reporting purposes, materiality shall be assessed in relation to the interim period financial data. In making assessments of materiality, it shall be recognised that interim measurement may rely on estimates to a greater extent than measurements of annual financial data. Xx Xx 25 While judgement is always required in assessing materiality, this Standard bases the recognition and disclosure decision on data for the interim period by itself for reasons of understandability of the interim figures. Thus, for example, unusual items, changes in accounting policies or estimates, and errors are recognised and disclosed on the basis of materiality in relation to interim period data to avoid misleading inferences that might result from non-disclosure. The over-riding goal is to ensure that an interim financial report includes all information that is relevant to understanding an entity s financial position and performance during the interim period. IAS 34 emphasises that it is events and transactions that are significant to an understanding of the changes in financial position and performance since the end of the last annual reporting period that are important to the interim financial statements. That Standard includes examples of the types of information that could be material, such as corrections of prior period errors, a breach of a loan agreement that has not been remedied and changes in the classification of financial assets as a result of a change in the purpose or use of those assets. 39 Interim measures sometimes rely on estimates to a greater extent than measurements of annual financial data. The examples in IAS 34 should be considered to assess whether they, or similar matters, need to be disclosed to meet the objective of the interim financial statements. 37 See paragraph 6 of IAS See paragraph IN9 of IAS IAS 34.15B Page 26

40 Appendix C Drafting suggestions (clean copy) IFRS Practice Statement Application of Materiality to Financial Statements Objective 1 The objective of this [draft] IFRS Practice Statement Application of Materiality to Financial Statements (the [draft] Practice Statement ) is to assist management in applying the concept of materiality to general purpose financial statements prepared in accordance with International Financial Reporting Standards (IFRS) and to help the users of financial statements understand how management assesses materiality. Scope 2 This [draft] Practice Statement is intended to be applied in preparing general purpose financial statements in accordance with IFRS. 3 Sometimes information is incorporated in the financial statements by cross-reference to another statement, such as a management commentary or risk report, that is available to users of the financial statements on the same terms as the financial statements and at the same time. 40,41 Without the information incorporated by cross-reference, the financial statements are incomplete. This [draft] Practice Statement also applies to information that is incorporated by cross-reference. General characteristics of materiality Introduction 4 Materiality is a general concept that is widely used both in financial reporting and for other purposes. For example, it is common for legal agreements to refer to material information, usually within a specific context such as referring to material changes to the terms of the offer which may or may not be financial in nature. 5 In many jurisdictions there are requirements that oblige listed entities to keep investors informed about aspects of their business on an ongoing basis. For example, during a takeover bid the parties might be required to keep markets informed about the terms of the takeover offer. There might also be ongoing obligations, beyond the requirement to file financial statements, to disclose price-relevant information known to the entity. Some jurisdictions use materiality principles, and supplementary guidance, to enforce these obligations. For example, an exchange may have guidelines on when a listed company issues a profit warning. These guidelines have probably been developed by considering the point at which information becomes material and should be publicly disclosed. 6 The way in which the term materiality is understood in the contexts above is expected to be consistent with the way in which the term is expected to be applied to financial reporting. However, IFRS contains a definition to help management apply the concept in preparing financial statements in accordance with IFRS. 40 Throughout this [draft] Practice Statement, the term financial statements refers to general purpose financial statements unless specifically indicated otherwise. 41 For example, see paragraph 21B of IFRS 7 Financial Instruments: Disclosure. Page 27

41 IFRS definition 7 Materiality is defined in the Conceptual Framework for Financial Reporting ( the Conceptual Framework ) as: Information is material if omitting it or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature and magnitude, or both, of the items to which the information relates in the context of an individual entity s financial report The words could influence in the definition of materiality are clarified in IAS 1, which states that the assessment of materiality should take into account how users could reasonably be expected to be influenced in making economic decisions on the basis of financial statements Financial statements are a type of general purpose financial report that summarise for external parties financial information that is recorded internally by an entity. Applying the concept of materiality ensures that financial information that could reasonably be expected to influence decisions that users make on the basis of those financial statements is separately presented in the primary financial statements (sometimes referred to as presenting information on the face of a financial statement ) or separately disclosed in the accompanying notes The concept of materiality is also intended to be applied as a filter to ensure that the financial statements are an effective and understandable summary of the information contained in an entity s internal accounting records. If information in the financial statements is not summarised or aggregated in a clear and helpful manner, for example if an excessive amount of immaterial information is disclosed or material information is obscured or concealed, it makes the financial statements less understandable for users. 45 Pervasiveness 11 The concept of materiality is pervasive to the preparation of financial statements. Requirements in IFRS must be applied if their effect is material to the complete set of financial statements. Similarly a requirement in IFRS need not be applied if the effect of not applying it is not material. Judgement 12 When assessing whether information is material to the financial statements, management applies judgement to decide whether information could reasonably be expected to influence decisions that the users make on the basis of those financial statements. When applying such judgement, management should consider both the entity s specific circumstances and how the information will be used by users of the financial statements. An entity s circumstances change over time and 42 See paragraph QC11 of the Conceptual Framework. However paragraph 2.11 of the Exposure Draft ED/2015/3 Conceptual Framework for Financial Reporting, proposes to modify this definition by including the word primary before the word user. There are similar definitions in IAS 1 Presentation of Financial Statements and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. 43 See paragraph 7 of IAS The term primary financial statements is expected to be defined as part of the Principles of Disclosure project. For the purposes of this [draft] Practice Statement, the primary financial statements comprise the financial statements excluding the notes. In other words, the primary statements consist of the statement of financial position, statement of comprehensive income, statement of changes in equity and statement of cash flows. 45 See paragraph 30A of IAS 1. Page 28

42 so materiality is reassessed in each reporting period in the light of the entity s circumstances during that period. This assessment should include comparing the current year information with comparative information for prior periods to assess changes in the entity s activities or circumstances during the period. Xx Xx Decision framework Critical to the application of materiality is a focus on the users of a particular set of financial statements. Those responsible for preparing a set of financial statements will need to: (a) understand who their primary users are and the types of decisions they will use the financial report to help them make; (b) identify the information that is likely to be relevant to those users, and from this information set, work out what is material to them; and (c) present the information in a meaningful way that emphasises those matters that are likely to be of most interest to the primary users. Materiality assessments are made in the context of the financial statements as a whole. It is therefore important for a preparer to assess the set of financial statements once it has been assembled to detemine that it presents fairly the financial position, financial performance and cash flows of the entity. That review should help in identifying any matters that should be addressed, by adding, removing or emphasising information. Primary users of the financial statements and their decisions 13 The definition of materiality refers to decisions made by the users of general purpose financial reports. The Conceptual Framework identifies the primary users of general purpose financial reports as existing and potential investors, lenders and other creditors who cannot require reporting entities to provide information directly to them and must rely on general purpose financial reports for much of the financial information they need. Other parties, such as regulators and members of the public other than investors, lenders and other creditors, may also find general purpose financial reports useful but they are not primary users Having identified the primary users of the entity s general purpose financial statements and other general purpose financial reports, management should consider the characteristics of those users, including their likely interests and what types of decisions they are making. This will then enable management to identify the information that the primary users could reasonably expect to receive and that could reasonably be expected to influence their decisions. Characteristics of the primary users of financial statements 15 A preparer is entitled to assume that the primary users of the financial statements have a reasonable knowledge of business and economic activities, but not that they are financial reporting experts. Users are expected to seek the assistance of advisers to help them understand information about complex economic phenomena. The users are also expected to review and analyse the information diligently Management should focus on typical and rational users, rather than a single, atypical user that is behaving unreasonably or irrationally. 46 See OB5 and OB 10 of the Conceptual Framework. 47 See QC32 of the Conceptual Framework. Page 29

43 17 An entity may have several different types of primary users. For example, the entity s investors may include individuals holding different classes of shares, institutional investors, bond investors, employees with options to buy shares and/or other types of investors. Across the range of possible primary users there may be a broad range of information needs and some may have dissimilar information needs and expectations. For example, some information might be useful to some primary users, but not others. If an entity has many classes of primary users, the financial statements should present and disclose information so as to meet the common information needs of a broad range of those classes. 18 Management cannot reasonably be expected to meet all of the information needs of all of the entity s primary users. For example, a single investor might be particularly interested in detailed information about an entity s expenditure in a specific location because that investor may also have a business operating in that location, but such detailed information may be inconsequential for the other primary users. 19 Nevertheless, information would usually be expected to be material if it is relevant to either a range of primary users across different classes or to a significant class of primary user (for example a class with a large number of users). Decisions made by the primary users of financial statements 20 The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. 48 X X Investors in debt or equity instruments are assumed to use financial reports to help them assess expected returns from instruments, to support decisions on whether to buy, hold or sell instruments. Those returns are dependent on the prospects for future net cash inflows to an entity. Some primary users could be more interested in corporate governance information, because their main decisions relate to exercising their voting rights, rather than making buy, hold or sell decisions. Accordingly, some information about director remuneration, for example, might be material to how they will vote on that matter but not material to an assessment of the value of the entity. Examples ways to identify information potentially useful to the primary users Gather information about through discussions with users or from information that is publicly available; Consider what decisions management themselves would seek to make and what information they would want as users of financial information in similar situations; Observe user or market responses to information or requests for information, for example on particular transactions or disclosures issued by the entity, or responses by external parties such as analysts; and Observe the types of information provided by entities operating in the same industry. However, while there are similarities 48 OB2, Conceptual Framework Page 30

44 X between entities in the same industry, it does not mean that the same kind of information will necessarily be material. General purpose financial reports can provide only some of the information that existing and potential investors, lenders and other creditors need. 21 In developing Standards, the IASB seeks to identify the information that is expected to meet the needs of a broad range of primary users, for a wide variety of entities. Consequently, when management considers what information should be provided in the financial statements, the requirements in IFRS should provide the basis for that assessment. The requirements within IFRS have been developed by the IASB taking into consideration the balance between the benefits of providing information to users of the financial statements and the costs of complying with those requirements. Consequently, the cost of applying the requirements in IFRS is not a factor for management to consider when assessing whether information is material. However, it is not sufficient to apply the presentation and disclosure requirements in a Standard mechanically, without considering the entity s specific circumstances, whether the entity s primary users have any special needs and whether the information provided meets or exceeds the needs of an entity s primary users. 23 Financial information is capable of making a difference to decisions if it has predictive value, confirmatory value or both. 49 The focus of the materiality assessment is whether the information could reasonably be expected to influence decisions made by users rather than whether that piece of information alone is capable of changing their decisions. Information is material if it confirms trends that could reasonably be expected to reinforce decisions made by the primary users. For example, an entity s earnings may have increased in line with expectations and this information may reinforce a decision to buy, hold or sell shares in the entity. Quantitative and qualitative assessment 24 The assessment of whether information is material depends on its size and nature, judged in the particular circumstances of the entity. 50 Consequently, applying materiality involves assessing qualitative and quantitative factors. 26 While quantitative thresholds are not in themselves determinative, they can be a helpful tool in applying the concept of materiality. A quantitative threshold may provide the basis for a preliminary assessment that an amount is likely to be material or immaterial; for example if it is below a specified percentage of profit or net assets. However, a materiality assessment also requires consideration of the nature of the item and the entity s circumstances. Consequently, it would not be appropriate for an entity applying IFRS to rely on purely numerical guidelines. Xx Xx Qualitative characteristics relate to the quality or nature of the matter being assessed, rather than the amounts involved such as for a receivable, the type, its terms, the type of counterparty, any security given by the counterparty, the currency it is denominated in and so on. The nature of the activity or item should inform management as to whether they should assign a higher or lower threshold in terms of the amounts involved. When it comes to assessing less usual items, IFRS already highlights some areas where the materiality threshold would be lower because of the nature of the information. IAS 24 Related Party Disclosure provides guidance for applying materiality. Its objective is to draw attention to the possibility that its 49 See paragraph QC7 of the Conceptual Framework. 50 See paragraph 7 of IAS 1. Page 31

45 Xx financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances, including commitments, with such parties. 51 Hence, for special relationships the threshold to warrant separate disclosure may be lower than for other day-to-day transactions. IAS 1 gives examples of circumstances that could warrant the separate disclosure of items of income and expense, because they are unusual. These include write-downs, or reversals of write-downs of inventories or of property, plant and equipment; the effect of restructurings; disposals of items of property, plant and equipment or investments; discontinued operations; litigation settlements; and reversals of provisions. 52 For example, simply disclosing the existence of a legal claim against the entity, which might not even have been recognised as liability, without explaining the circumstances is unlikely to meet the requirements of IFRS. Examples qualitative factors In deciding whether a particular accounting policy should be disclosed, management considers whether its disclosure is necessary to understand the financial statements. A description of an accounting policy would be material by its nature if the primary users would be unable to understand the financial statements sufficiently for their decision-making purposes if it were not disclosed. An example of an inadequate and potentially immaterial disclosure would be when an entity simply quotes the requirements within IFRS without tailoring the description of its accounting policy to explain how it has been applied by the entity. In considering the materiality of uncertainties and contingencies, the monetary amounts involved are not always known or may have a potentially wide range of outcomes. Consequently, when making judgements on whether information about these uncertainties and contingencies is material, management considers factors such as the nature of the items, their potential financial effect and timing of cash outflows. Accordingly, even if the outcome of a lawsuit is uncertain, information about that lawsuit is likely to be material if the consequences of an unfavourable finding would be significantly detrimental to the company. 53 If a fair value estimate of material assets recognised in the financial statements is particularly sensitive to assumptions about sales volumes, that assumption is likely to be material. If the economic benefits of land acquired for the purposes of expanding a production facility are dependent on the company being granted a change in permitted use of the land, this 51 IAS 24, paragraph IAS 1, paragraph Key factors to consider can often be determined by looking at the IFRS disclosures for those items for example, see paragraph 85(b) of IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Page 32

46 Xx information is likely to be material if the land itself is material to the entity. For some matters, materiality considerations will be more sensitive because they relate to key statistics used by the primary users, or to targets communicated by management, or otherwise relate to areas of particular importance to the primary users. Examples Sensitive items Transactions that could trigger non-compliance with regulatory requirements or loan covenants. Events that are likely to affect the cash flows of the entity in a future but foreseeable period, such as the successful outcome of an important drugs trial or the entity s involvement in an environmental accident. Rare or unusual transactions, for which the reasons for undertaking them could reasonably be expected to influence decisions made by the primary users. For example, a transaction may be unusual because it was on special terms with a related party of the entity. Xx Specific balances There might also be circumstances when lower thresholds are applied to specific balances. This could be because of legal requirements or because of special circumstances that are relevant during the current period. Examples specific balances In some jurisdictions the financial report must include information about country-by-country tax payments. In many circumstances that requirement is absolute and is outside normal materiality decisions. A jurisdiction may have a general requirement for disclosure of information about business undertaken in specified countries, perhaps because of trade restrictions. Particular disclosures in relation to an industry in which the entity operates may be important, such as research and development costs in a technology company. Individual and collective assessment 29 The assessment of whether information is material or immaterial should be undertaken on both an individual and a collective basis. 54 Even if information is judged not to be material in isolation (ie it is considered immaterial), it might be material when considered together with other information (for example see paragraph 39(c)). Xx The assessment will need to include how the matter affects performance metrics that are important to the primary users. It could be that EBIT or EBITDA are particularly important in some sectors, and 54 See paragraph 7 of IAS 1. Page 33

47 Xx this could be a factor to consider. In a similar manner, for an entity in a start-up phase revenue might be more important than net income. An item that is reported in other comprehensive income (OCI) should not be considered to be less important than items reported in profit or loss solely because of that fact. Whether the specific information is material will depend on how it affects the financial statements as a whole. Presentation and disclosure in the financial statements The context of the materiality assessment 30 The primary objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Judgements on whether information is material should be made within the context of this objective and by considering the complete set of financial statements (ie the primary financial statements together with the notes). Financial statements also show the results of the management s stewardship of the resources entrusted to it Management should also assess whether information is material within the context of the different parts of the financial statements; for example: (a) whether and how information should be presented separately in the primary financial statements; (b) whether and how information should be included in the notes; and (c) whether the assessment in paragraph 31(a) or (b) changes after reviewing the complete set of financial statements. 33 The last step in paragraph 31(c) would include an assessment of the overall mix of information in the financial statements. This overall assessment could lead to a reassessment of how information is presented or disclosed in order to make it more understandable or give it increased prominence. The overall assessment may also identify that some information should be supplemented (for example to highlight key trends) or be removed (for example if it is sufficiently covered by other information). Immaterial information 34 Providing immaterial information in the financial statements may obscure material information. For example, if an entity discloses detailed information about transactions that do not have a material effect on the entity s reported financial position or financial performance this may make the material information harder to find. Disclosing immaterial information increases the length of financial statements, makes them less understandable and requires the primary users to spend more resources in searching for material information. 55 See paragraphs 9 of IAS 1 and paragraph OB2 of the Conceptual Framework. Note: paragraph 3.4 of the Exposure Draft Conceptual Framework for Financial Reporting is proposing to modify the description of the objective of financial statements (and includes an explicit discussion of stewardship considerations) as follows: The objective of financial statements is to provide information about an entity s assets, liabilities, equity, income and expenses that is useful to users of financial statements in assessing the prospects for future net cash inflows to the entity and in assessing management s stewardship of the entity s resources. Page 34

48 35 IFRS does not prohibit entities from disclosing immaterial information. Nevertheless, it requires them to consider whether disclosure of immaterial information results in material information being obscured In some cases it might be helpful to disclose the fact that a particular issue is immaterial to the entity. For example, management may wish to inform the primary users that the entity is not exposed to a particular risk normally associated with an item that is of particular interest to market participants. This could be achieved by making a simple statement rather than including detailed information or analysis about the amount or nature of the item. For example, an international bank may explain that it does not hold a material amount of debt in a particular jurisdiction or industry that is suffering severe financial difficulties, without providing further information. In this case, the statement that the entity is holding an immaterial amount of debt may provide material information about how effective management has been in protecting the entity s resources from unfavourable effects of economic conditions. Xx Focusing on information that is specific to the business can help filter out boiler-plate, generic, disclosures which can also reduce clutter. For example, the accounting policy information presented in the financial statements should focus on how the policies are relevant to the business and how management has applied them. Primary financial statements versus the notes Primary financial statements 40 The primary financial statements provide a structured summary of the entity s: (a) recognised assets, liabilities, equity, income and expenses; (b) cash flows; and (c) contributions from, or distributions to, holders of equity claims. 41 The role of the primary financial statements in meeting the objective of financial statements is to provide information that gives an overview of the financial position and performance of an entity. Such an overview may be useful for the primary users as follows: (a) obtaining essential information about the entity s assets, liabilities, equity, income, expenses, cash flows and contributions and distributions from/to holders of equity claims; (b) understanding the past financial position and performance of the entity in order to forecast net cash inflows and to understand trends; (c) making high-level comparisons between entities and reporting periods; and/or (d) identifying areas of particular interest for which the user could expect to find additional information in the notes When assessing which line items should be presented on the face of a primary financial statement, management considers how to provide a representative summary of the financial information of the entity for example, it considers which items or classes of items should be presented separately because of their relative size or their nature. Management should also consider the degree of similarity or 56 See paragraphs 30A and BC30F of IAS The guidance in paragraphs 41, 45 and 47 is drafted in line with the IASB s initial thinking during its Principles of Disclosure project see paragraph BC21 of the Basis for Conclusions on this [draft] Practice Statement. Page 35

49 difference between individual line items when determining whether those items should be combined or presented separately. 43 The materiality of an item is assessed relative to individual line items, subtotals and totals on the face of an individual statement, as well as to each overall individual statement. Consideration should also be given to the relationships between each of the primary financial statements, including assessing which items serve as useful signposts to link the face of the statements with the detail in the notes to help the primary users navigate through the financial statements. 44 If recognised items are not presented separately in the primary financial statements, then consideration should be given to how they should be aggregated with other items (see paragraphs 37 39). Notes 45 Because of their structure, the amount and type of detail that can be included in the primary financial statements is limited. The notes: (a) (b) explain the information presented in the primary financial statements in greater detail; and supplement the primary financial statements with additional information that is necessary to meet the objective of financial statements (see paragraph 30). 46 Although the concept of materiality does not change when applied to the notes, the context in which that concept is applied is different. This is because the notes have a different role from the primary financial statements in meeting the objective of financial statements (see paragraphs 40 44). Consequently, this may result in different conclusions regarding whether information is material in the different contexts and whether further disaggregation in the notes is necessary compared to the face of a primary financial statement. 47 One of the main objectives of the notes, as an integral part of the financial statements, is to amplify and explain the items in the primary financial statements. Information that is material to the financial statements, but for which separate presentation in the primary financial statements is not material, is provided in the notes. Nevertheless, if information is material in the context of the primary financial statements then disclosure in the notes is not sufficient. For example, management may decide to present only a single amount for total revenue on the face of the statement of comprehensive income. In the notes management should disaggregate the amount and disclose further information, as appropriate, to enable the primary users to understand the nature, amount, timing and uncertainty of the revenue and related cash flows. 48 In addition to amplifying and explaining the items in the primary financial statements, the notes also provide any other financial information that is necessary to meet the objective of financial statements (see paragraph 30) and could reasonably be expected to influence decisions of the primary users. Some information typically found in note disclosures does not relate to line items in the primary financial statements; such as material non-adjusting events after the balance sheet date. Furthermore, some information relates to items that are not recognised, such as contingent liabilities. xx Aggregating and disaggregating information Financial statements result from processing large numbers of transactions or other events that are aggregated into classes according to their nature or function. The final stage in the process of aggregation and classification is the presentation of condensed and classified data, which form line items in the financial statements. If a line item is not individually material, it is aggregated with other Page 36

50 items either in those statements or in the notes. The primary financial statements should present separately each material class of similar items so that items that are dissimilar by nature or function are not aggregated, unless those items are immaterial. 38 If a line item in the primary financial statements is not individually material, it does not need to be disaggregated further, and it can be aggregated with other related or similar items even if IFRS prescribes separate presentation. However, an item that is not material in the primary financial statements may warrant separate presentation in the notes. For example, management may decide to combine all of its financial assets that are measured at fair value through profit or loss together in one line item on the face of the statement of financial position, if separate presentation is not considered material within the context of the primary financial statements. 39 Aggregating information means that information about the components becomes less detailed. Hence, making judgements about whether to aggregate information, either in the primary financial statements or in the notes, requires an assessment of whether material information would be lost through aggregation. Examples aggregation and separate presentation or disclosure If an entity has many similar leases of similar assets, then combining them together for disclosure purposes is unlikely to lead to a loss of material information. However, if a subset of those leases has different characteristics from the others (such as residual value guarantees or extension options), separate information about that subset may be material. An entity may have a small net foreign exchange difference as a result of transactions in foreign currencies from a large number of small exchange gains on a broad base of recurring transactions and a substantial loss that resulted from one speculative forward foreign exchange transaction. IAS 21 The Effects of Changes in Foreign Exchange Rates specifies only that the amount of exchange differences is disclosed. When making judgements about materiality, the entity should assess whether the loss should be reported separately from the other exchange differences. The fact that a large loss was incurred relative to the other transactions, and that the loss was from speculative activity, suggests that aggregating these exchange differences would result in a loss of material information. In this scenario, information that could influence users opinions of management s stewardship would be lost through aggregation. An entity might acquire many small businesses during the reporting period. Each acquisition might be individually immaterial, but in aggregate the acquisitions could change the structure and prospects of the business in a material way. Because it is the aggregated effect of the business combinations that is material, it may be appropriate to include information about the acquisitions in aggregate. Disclosures specified in IFRS 50 The disclosure requirements in IFRS are the basis for management to decide what information should or should not be disclosed in the notes. When a Standard contains a disclosure requirement and the Page 37

51 related information to satisfy that requirement is material, then management should disclose that information in line with the IFRS requirement. However, this does not mean that IFRS disclosure requirements should be treated as a checklist, without regard to the entity s circumstances and the needs of its primary users. Management is not required to provide disclosures in the level of detail specified by a Standard, or even provide them at all, if the related information is not material, because immaterial information does not need to be disclosed When Standards contain disclosure objectives, management should make an overall assessment of whether it has satisfied those objectives for material information. This includes considering: (a) (b) whether financial statements provide all the specified disclosure requirements related to an objective; and whether information in addition to that specified in the Standards should be disclosed to meet those objectives and help users understand the information provided. 52 An entity must also provide information in addition to the information specified in IFRS if that information is relevant to an understanding of the financial statements and could reasonably be expected to influence decisions that the primary users make on the basis of the financial statements. Examples IAS 16 Property, Plant and Equipment An entity that does not have material contractual commitments for the acquisition of property, plant and equipment need not disclose immaterial commitments, even though it is specified in IAS 16.74(c). If an entity has several large plans and some smaller plans, it may be sufficient to disclose only the key risks and sensitivities for the smaller plans, rather than the detailed items set out in IAS 19 Employee Benefits. If share-based payments are material to the financial statements, the entity considers which information required by paragraphs of IFRS 2 Share-based Payments is useful to the primary users and also whether any additional information should be disclosed. In some cases, instead of disclosing all the information in paragraphs of IFRS 2, it might be appropriate to summarise some information, such as providing a range of vesting periods, if that does not lead to the loss of material information. IFRS 8 Operating Segments provides criteria that management should consider as part of its materiality judgements, including segment aggregation criteria, and quantitative thresholds for segments. IFRS 12 Disclosure of Interests in Other Entities specifies information that must be disclosed in relation to each subsidiary with material non-controlling interests. In considering whether a non-controlling interest is material it would be appropriate to consider the size of the NCI relative to other components of 58 See IAS 1.31 Page 38

52 equity as well as the assets and liabilities in the affected subsidiary relative to the assets and liabilities of the group. Reviewing note disclosures at each reporting date 54 If a disclosure was material to the prior period s financial statements, but the same level of detail or type of information is not material to the current-year financial statements, the full comparative information might not need to be repeated. The information could be summarised or in some cases omitted altogether provided that, for example, information needed to identify key financial trends, is not lost. Examples comparative information Xx It might be appropriate to summarise a previous business combination rather than reproduce all of the detail provided in the prior period s financial statements. A detailed reconciliation of property, plant and equipment may have been included in the prior year financial statements because of changes that took place in that period. In the current period it might be appropriate to aggregate some of the comparative information. If an impairment loss was recorded for an item of plant or machinery in the prior year, but not in the current year, then detailed disclosures about the measurement basis, such as the fair value hierarchy and techniques might not be material in the current year. It may be changes related to prior periods rather than the absolute quantitative amount in the current period that is material. Examples Changes from prior periods Information about a business combination that took place in a prior period might be material in the current period if it enables the primary users to understand the effect of the combination on the performance for the current reporting period such as the effects of adjustments or contingent consideration settlements recognised in the current reporting period. A fall in sales of a major product from a material amount in the prior year to an immaterial amount in the current year may be a material change that should be identified in the current year. Complete set of financial statements 56 IAS 1 requires an assessment of whether information is material individually and collectively. Consequently, the assessment of whether an individual piece of information is material in the financial statements is not made in isolation. This assessment should also consider whether the information is material in combination with other information in the complete set of financial statements. This wider perspective enables consideration of the overall picture of the entity s financial position, financial performance and cash flows, including information about financial trends. It also enables an overall assessment of whether information in the financial statements is communicated in an effective and understandable way. For example consideration should be given to whether matters of particular Page 39

53 importance have been given sufficient prominence and whether related information is presented in such a way that the linkage is clear. 57 The primary users of financial statements consider information in a wider context than the financial statements. For example, they also consider other sections of the financial report, information about the industry that the entity operates in and its competitors, and about the economy in general. Consequently, the assessment of whether and how information should be disclosed in the financial statements may depend on the availability of other information from publicly accessible sources. Nevertheless, public availability of information does not relieve the entity of the obligation to disclose information that is specifically required by IFRS in the financial statements if that information is material. 58 The financial statements are intended to be a comprehensive document that provides information about the financial position, financial performance and cash flows of an entity that is useful to the primary users in making decisions. Consequently it would not be appropriate to omit information that is specifically required by IFRS about the entity from the financial statements solely because it had previously been included in a press release or other publicly available document. Information incorporated by reference would be considered to be part of the financial statements. Xx Xx Xx Presentation and emphasis How information is presented is part of the materiality assessment, because presentation can affect its usefulness, and how it is perceived by the primary users. In other words, presentation matters if it can influence or affect the decisions taken by the primary users. It is not sufficient to argue that the information was included in the report, if it is difficult to find. Nor is it appropriate if information that should be considered together, to provide a more complete picture of an aspect of the business, is presented as if it is not related. Providing more emphasis to some aspects of a transaction while deemphasising other aspects can undermine neutrality. Part of the materiality decision involves identifying which matters should be given particular emphasis and which matters should be presented together, or at least related to each other by way of crossreference. Among the factors that should be considered are: (a) Is the tone of the language used appropriate to the issue being conveyed? For example, a dismissive tone when discussing possible litigation against the entity when the litigant has reasonable grounds would not be appropriate. (b) Are matters of particular importance give sufficient prominence? (c) Is the information formatted in a way that communicates effectively? For example, data intensive disclosures such as maturity analysis or reconciliations are generally clearer when presented in a table. (d) Are there any notes which have superfluous information that obscures the material information, such as generic statements that do not help the reader understand the particular circumstances of the entity? Recognition and measurement 61 Much of the content of this [draft] Practice Statement focusses on providing guidance on the application of materiality when presenting and disclosing information in the financial statements. However, similar considerations also apply to the recognition and measurement of the information that is provided in the financial statements. Page 40

54 Recording procedures 63 IFRS does not specify requirements for an entity s internal record keeping procedures. Consequently, management might decide not to apply a requirement in a Standard when it records a particular item, provided it later makes an adjustment to ensure the information is in accordance with IFRS for financial reporting purposes. For example, an entity might maintain a periodic inventory system and then later adjust amounts for the purchases and inventory for financial reporting purposes based on physical stock counts. 66 Provided information is fairly presented in accordance with IFRS in the financial statements, it is beyond the scope of IFRS to specify how that information is recorded internally. Nevertheless, there may be legal requirements in an entity s jurisdiction that prescribe requirements for an entity s internal record-keeping procedures. Recognition expedients 64 An entity might have a policy of capitalising capital expenditures only in excess of a specified threshold and recognising smaller amounts as an expense. Management has assessed that this departure from IFRS will not have a material effect on the current financial statements or future financial statements, because it is clear such expenditure is not material, and a different accounting treatment to that required by an IFRS could not reasonably be expected to influence decisions made by the primary users. Provided that such a practice does not have a material effect on the financial statements, it would not prevent the entity s financial statements from complying with. Such a policy should nevertheless be reassessed periodically to ensure that these assumptions remain appropriate. 65 It is also conventional for entities to round reported information, such as to the nearest thousand or million, when preparing the financial statements. The chosen unit is set sufficiently low to ensure that the resulting loss of precision and detail is immaterial. Omissions and misstatements ( misstatements ) Identified misstatements 67 Omissions (ie excluding relevant data/information), errors and other misstatements of information (eg describing information ambiguously or obscuring material information) (collectively referred to as misstatements in this document) are material if, individually or collectively, they could reasonably be expected to influence decisions that the primary users make on the basis of the financial statements. Management should assess whether misstatements of information are material to the financial statements. This assessment includes considering any misstatements in the comparative information included in respect of prior periods. 68 Errors are a type of misstatement in the entity s financial statements arising from a failure to use, or misuse of, reliable information that: (a) was available when financial statements for those periods were authorised for issue; and/or (b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. 59 Such errors include the effects of arithmetical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud (such as an employee misappropriating funds). 59 Derived from the definition of a prior period error in paragraph 5 of IAS 8. Page 41

55 69 In assessing whether misstatements are material, management should take into account how precisely transactions can be measured. For example most cash disbursements or cash sales are capable of precise measurement and so misstatement of these transactions would not be expected to occur frequently if an entity has effective internal controls. For other transactions, precise measurement will not be possible and management is required to make estimates; for example provisions for expected environmental clean-up costs 23 or Level 3 fair value measurements. 60,61 Because of the uncertainty inherent in estimates, it may be more difficult to assess misstatements in these situations. Consequently, the disclosures in the financial statements should ensure that the primary users are made aware of the subjectivity involved in recognising and measuring such items. When considering whether an adjustment should be treated as a change in estimate or the correction of an error management should be guided by the requirements in IAS 8. Current period misstatements 70 Two common examples of situations in which management may identify that it has misstated information in the entity s financial statements are: (a) (b) in preparing the financial statements, bookkeeping errors are identified. Examples could include a mathematical error in an adjusting journal entry, or a double counting or omission of a physical inventory count. after the preliminary announcement of financial information and/or after the financial statements have been prepared but not yet authorised for issue, additional relevant information could be identified. 71 The financial statements should be amended for all material misstatements identified before they are authorised for final issue, regardless of the cost of doing so. 62 Furthermore, it would be considered good practice to corrects all misstatements, even those that are not material. However, in some circumstances correcting an immaterial misstatement may be unduly costly or delay publication of an entity s financial statements. In such a case, an evaluation should be made of all identified misstatements to consider whether, in relation to individual line items, subtotals, or totals in the financial statements, failure to address those misstatements could result in a material misstatement and hence result in non-compliance with IFRS. This requires consideration of the pervasiveness of the misstatements in the financial statements (eg whether they affect numerous line items). For example, an error recorded on a purchase of inventories will affect other balances such as trade payables, cost of sales and closing inventory. 72 IAS 1 requires an assessment of whether information is material individually and collectively. Consequently, management first considers whether each misstatement is material, irrespective of its effect when combined with other misstatements. If the misstatement causes the financial statements to be materially misstated, that effect cannot be offset by other misstatements. For example, if an entity s investment income is material within the context of the financial statements and it is materially overstated, the financial statements will be materially misstated even if the effect on profit is completely offset by an equivalent overstatement of expenses. 60 See measurement guidance in IAS See measurement guidance in IFRS 13 Fair Value Measurement. 62 See IAS 10 Events after the Reporting Period for the requirements about the date when the financial instruments are authorised for issue. Page 42

56 73 Consideration is then given to whether the misstatements are collectively material. Even if a misstatement is judged not to be material on its own, it might be material when considered with other information. Prior period errors 74 Prior period errors are errors in the entity s financial statements for one or more prior periods. IAS 8 requires that such error be corrected retrospectively in the first set of financial statements authorised for issue after the error is discovered Errors in a prior period are sometimes not discovered until the current period. Any material prior period errors are corrected retrospectively by amending the comparative information presented in the financial statements unless it is impracticable to determine either the period specific effects or the cumulative effect of the error Errors made in one period can affect future periods. The effect of errors made in a previous period, and that were identified at the time, therefore need to be considered in the current period. It could be that the natural reversing on the errors in combination with other matters from the current period results in a material misstatement of information in the current period financial statements. Xx Xx Xx Misstatements made with the intention of misleading If management intentionally misstates items to achieve a particular presentation or result it does so knowing that the financial statements will be misleading. That intention to mislead makes the misstatement material and the financial statements will not comply with IFRS. In contrast, deciding not to apply a requirement in an IFRS or deciding not to correct the financial statements for trivial errors does not make those matters material, if management has concluded that the effect will not lead to a material difference in the financial statements. For example there is a difference between management deciding not to discount a liability to reflect the time value of money when there is no material difference between the discounted and non-discounted value and management deliberately choosing to use an inappropriate discount rate in order to reduce the amount of the liability with an intention of misleading the users of the financial statements. Review of the financial statements Xx Materiality judgements involve assessing whether more or less information about particular matters should be included in the set of financial statements report to make it fair, balanced and understandable. Reviewing the financial statements before they are authorised for issue provides those responsible for preparing them with the opportunity to consider whether: (a) any information that could be removed, or summarised further, to make sure the information known to be important to the primary users is more accessible; (b) there are gaps in the information that need to be remedied; (c) the report is structured in a way that gives appropriate emphasis to the matters they know were important to the entity during the period and (d) the tone and language are balanced. 63 IAS 8, paragraph See paragraph 43 of IAS 1. Page 43

57 Interim reporting 59 The same general principles on the application of materiality to the annual financial statements also apply to interim financial statements. However, the context and objectives in which the concept is applied are different. This is because the objective of interim financial statements is different from the objective of annual financial statements. In particular, interim financial statements are intended to provide an update on the latest complete set of annual statements. Accordingly, interim financial statements focus on new activities, events, and circumstances and do not duplicate information previously reported Furthermore, even though IAS 34 Interim Financial Reporting regards interim financial statements as an update of the latest annual financial statements, IAS 34 specifies that materiality for interim financial statements is assessed in relation to the interim period financial data, not forecast annual data. 66 Xx Xx IAS 34 emphasises that it is events and transactions that are significant to an understanding of the changes in financial position and performance since the end of the last annual reporting period that are important to the interim financial statements. That Standard includes examples of the types of information that could be material, such as corrections of prior period errors, a breach of a loan agreement that has not been remedied and changes in the classification of financial assets as a result of a change in the purpose or use of those assets. 67 The examples in IAS 34 should be considered to assess whether they, or similar matters, need to be disclosed to meet the objective of the interim financial statements. Interim measures sometimes rely on estimates to a greater extent than measurements of annual financial data. 65 See paragraph 6 of IAS See paragraph IN9 of IAS IAS 34.15B Page 44

58 Thinking allowed Materiality Judgements around financial report disclosure