How should materiality be applied? FASB weighs in

FASB issued two exposure drafts Thursday that address the use of materiality—an attempt to help organizations eliminate unnecessary disclosures in financial statements.

Feedback received by FASB indicated that the current discussion of materiality in the board’s conceptual framework is inconsistent with the legal concept of materiality established by the U.S. Supreme Court, FASB Chairman Russell Golden said in a news release.

That created uncertainty about organizations’ abilities to interpret which disclosures are material, as well as FASB’s ability to identify and evaluate disclosure requirements in accounting standards, according to Golden.

“These proposals are intended to clarify materiality—which will help organizations improve the effectiveness of their disclosures by omitting immaterial information, and focus communication with users on the material, relevant items,” Golden said.

The proposals are part of the disclosure framework project FASB is undertaking to improve the effectiveness of disclosures in notes to financial statements. The proposals address the use of materiality in two ways:

• Helping organizations use discretion when determining which disclosures in notes to financial statements should be considered “material,” and
• Helping FASB understand the reporting environment in which it sets accounting and reporting standards.

One of the exposure drafts issued Thursday proposes amendments to Chapter 3 of FASB Concepts Statement No. 8, Conceptual Framework for Financial Reporting, and is intended to clarify the concept of materiality.

The other exposure draft, Proposed Accounting Standards Update, Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material, aims to promote the appropriate use of discretion when organizations decide which disclosures they should consider material. The amendments to ASC Topic 235 would apply to all types of organizations—public and private companies, not-for-profits, and employee benefit plans.

In a 2012 comment letter replying to a FASB discussion paper, James G. Campbell, Intel’s vice president for finance and corporate controller, wrote that disclosure effectiveness requires application of materiality. The letter said the appropriate threshold for materiality is consistent with the Supreme Court’s interpretation of materiality, and that FASB Concepts Statement No. 8’s discussion of materiality can lead organizations to a threshold that is too low and exacerbates disclosure overload.

“Materiality assessments for disclosures are not occurring as often as they should,” the letter said.

A 2012 comment letter from the American Gas Association encouraged FASB to clearly define materiality and relevance with a focus on limiting disclosures in financial statement notes.

“Unless the Board enhances the materiality and relevance guidance, reporting entities may choose to avoid being challenged by independent auditors, legal advisers, and regulators by not making any changes to their notes or even including immaterial disclosures,” wrote Stephen P. Feltz, chairman of the American Gas Association Accounting Advisory Council.

FASB’s proposals would:

• Make it clear that FASB does not define materiality.
• Delete the existing discussion of materiality in Chapter 3 of FASB Concepts Statement No. 8 and replace it with a broad observance of the Supreme Court’s definition of materiality.
• State that materiality is applied to quantitative and qualitative disclosures individually and in the aggregate in the context of the financial statements taken as a whole. Therefore, some, all, or none of the requirements in a disclosure may be material.
• Refer to materiality as a legal concept.
• State that an omission of immaterial information is not an accounting error.

Comments are sought by Dec. 8 and can be submitted at FASB’s website.

—Ken Tysiac (ktysiac@aicpa.org) is a JofA editorial director.