New FASB Proposals Aimed at Clarifying Materialityby
In an effort to make financial statement disclosures more effective for organizations, the Financial Accounting Standards Board (FASB) on Sept. 24 issued two exposure drafts that address the concept of materiality.
The use of materiality is a key component of the FASB's disclosure framework project, the objective of which is to improve the effectiveness of disclosures in notes to financial statements. As part of the project, the exposure drafts address the use of materiality in:
- Helping organizations employ discretion when determining what disclosures in notes to financial statements should be considered âmaterialâ in their particular circumstances.
- Helping the FASB understand the reporting environment in which it sets financial accounting and reporting standards.
The FASB revisited the concept of materiality after stakeholders indicated that the current discussion of materiality in the board's conceptual framework was inconsistent with the legal concept of materiality established nearly 40 years ago by the US Supreme Court.
Federal law requires public companies to disclose material information, as defined by the High Court in 1976 in TSC Industries Inc. v. Northway Inc., that would present âa substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the âtotal mix' of information made available.â
This inconsistency âled to uncertainty about organizations' abilities to interpret what disclosures are material and the board's ability to identify and evaluate disclosure requirements in accounting standards,â FASB Chairman Russell Golden said in a written statement.
âThese 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,â he added.
The exposure draft containing amendments to FASB Concepts Statement No. 8, Conceptual Framework for Financial Reporting, aims to clarify the concept of materiality. Specifically, these amendments would be made to Chapter 3, Qualitative Characteristics of Useful Financial Information.
The FASB decided that the simplest and most effective way to avoid creating uncertainty or confusion was to:
- Make it clear that the FASB does not define materiality.
- Delete the existing discussion and replace it with a broad observation of the US Supreme Court's definition of materiality.
The second exposure draft, Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material, intends to promote the appropriate use of discretion by organizations when deciding which disclosures should be considered material in their particular circumstances. The amendments to Topic 235 would apply to all types of organizations: public and private companies, not-for-profit organizations, and employee benefit plans.
The amendments in the exposure draft:
- 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 specifically that an omission of immaterial information is not an accounting error.
Written comments on both exposure drafts should be submitted to the FASB by Dec. 8. Instructions on how to submit comments are contained in the exposure drafts.