In 2015, FASB sent a number of stakeholders into a tizzy when it issued two exposure drafts, part of its disclosure framework project, intended to “clarify the concept of materiality.” After hearing from any number of preparers, practitioners and other commenters, FASB has now reversed course. According to FASB, the “main amendment” in Amendments to Statement of Financial Accounting Concepts No. 8, issued at the end of August, “reinstates the definition of materiality that was in FASB Concepts Statement No. 2, Qualitative Characteristics of Accounting Information, which was superseded in 2010.” In other words, it’s back to SAB 99.
According to the Amendments, the 2015 exposure draft would have modified the then-current definition of “materiality” to add a statement that materiality was a legal concept, defined by SCOTUS in TSC Industries v. Northway and Basic v. Levinson in the securities law context: generally, “information is material if there is a substantial likelihood that the omitted or misstated item would have been viewed by a reasonable resource provider as having significantly altered the total mix of information. Consequently, [FASB] cannot specify or advise specifying a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation.” The Accounting Standards Update (ASU), Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material, also proposed in 2015, was “intended to promote the appropriate use of discretion by organizations when deciding which disclosures should be considered material in their particular circumstances.” A key objective was to improve the effectiveness of financial statement notes by assisting companies to omit immaterial information and focus communication on material, relevant information. (See this PubCo post.)
The proposals, however, faced an onslaught of criticism from commenters. For example, the SEC’s Investor Advisory Committee submitted a comment letter urging FASB to scrap its proposal. (See this PubCo post.) According to the Amendments,
“[p]reparers and practitioners objected to stating that materiality is a legal concept because it may imply that only legal professionals can make materiality judgments and that materiality should be considered an accounting concept. Others objected to the citing of the U.S. Supreme Court definition of materiality because of its origins in antifraud litigation. Still others stated that the meaning of the term is debatable and there is a concern that the definition may change. Some stakeholders suggested that the definition in Concepts Statement 2 would be a better definition. After considering the feedback, the Board decided to replace the current definition of materiality… with the superseded definition in Concepts Statement 2 [, which] is quoted in SEC Staff Accounting Bulletin No. 99, Materiality. SAB 99 notes that the definition that is in Concepts Statement 2 is in substance identical to the definition of the U.S. Supreme Court, which in turn results in the definition in this chapter being in substance identical to the definition in the auditing standards of the AICPA and the PCAOB.”
The Amendments provide, in relevant part, that the
“omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item….A decision not to disclose certain information or recognize an economic phenomenon may be made, for example, because the amounts involved are too small to make a difference to an investor or other decision maker (they are immaterial). However, magnitude by itself, without regard to the nature of the item and the circumstances in which the judgment has to be made, generally is not a sufficient basis for a materiality judgment…. No general standards of materiality could be formulated to take into account all the considerations that enter into judgments made by an experienced, reasonable provider of financial information. That is because materiality judgments can properly be made only by those that understand the reporting entity’s pertinent facts and circumstances. Whenever an authoritative body imposes materiality rules or standards, it is substituting generalized collective judgments for specific individual judgments, and there is no reason to suppose that the collective judgments always are superior.”
Notably, in its Disclosure Update and Simplification, the SEC observed that it believes “these decisions by the FASB have clarified that the concept of materiality has not changed from the historical view of how an issuer applies materiality to the financial statements…. Issuers should continue to consider both quantitative and qualitative factors in assessing materiality for the accounting and disclosure of an item….”