IFRS Practice Statement: Application of Materiality to Financial Statements

Discuss about the Corporate Reporting Theory and Practice.

The purpose of this report is to discuss and analyse the exposure draft, International Financial Reporting Statements (IFRS) practice statement: Application of Materiality to Financial Statement developed by International Accounting Standards Board (IASB). The purpose of this exposure draft is to enable the preparers of financial reports to understand and assist them in utilizing the concept of materiality to general-purpose financial statements to be developed in accordance with IFRS. The report, therefore, would review the Exposure Draft, the Comment Letters from interested parties on the Exposure Draft, and other related sources. The report, critically evaluate whether the proposed Practice Statements in the Exposure Draft would assist the preparers of financial statements in providing useful information and users of financial information (shareholders and investors) in making economic decisions.

IFRS Practice Statement: Application of Materiality to Financial Statements

The objective of general-purpose financial statements is to present relevant financial information about the reporting organization in such a manner that is beneficial to the current and potential investors, shareholders, and other creditors in making financial decisions. The Exposure Draft of the IFRS Practice Statement is formulated to provide guidance and to assist financial managers in implementing the concept of materiality to general-purpose financial statements to be prepared in accordance with IFRS. Further, information is said to be material if excluding or misrepresenting it could influence end user’s decisions, which is based on specific reporting entity (Singh and Peters 2015).

The proposed Exposure Draft would enable the preparers of financial statements in improving the management’s understanding and assessment of materiality and would improve communication between the reporting organization and other parties such as auditors by providing a common platform for materiality discussions. IASB have issued the guidance as a non-mandatory Practice Statement as this is a just a guidance and should involve judgement on the part of preparers of financial statements (Cornelissen 2014).  Practice statement acts a productive tool for assisting finance managers and other individuals who are responsible for preparation of financial statements. It also helps to highlight and to focus on matters which are of significant relevance to users while analysing the investment options. Further, making the Practice Statement as mandatory may result in inappropriate disclosures in the long-term, as the reporting entity might feel constrained in applying judgement for the cases that are under consideration and may opt for the safer outcomes of including a disclosure with a view to reducing the risk of an unfavourable audit opinion (Frias et al. 2013).  In addition, if the Practice Statement is issued as a mandatory form, preparers of financial reports in the small entities who are less sophisticated, might look for prescriptive guidance and the approach would become rigid, thereby reducing the element of judgement in defining, what an entity considers as material information and what does not (Edgley et al. 2015). It is difficult in Practice Statement to provide a clearly defined framework to cover all possible situations; hence, the examples provided are helpful to exemplify the thought process that needs to be applied while considering materiality, particularly while accessing the consideration of marginal situations. Despite the examples in the draft Practice Statements to be helpful, but is too straightforward. However, the guidance would be more helpful, especially to the preparers in small organizations; if it includes both straightforward or direct examples and the examples that address situations that are more difficult and where the materiality assessment is more subjective. Further, practice statement also deals with misstatements of information such as presenting information ambiguously or obscuring material information. Therefore, it would be beneficial for the preparers of financial statements, if Practice Statements provides an example to show how the materiality of ambiguous material information is accessed (Crawford and Power 2015). It would be helpful if the Practice Statement provides proper definition of materiality, its subjective nature, and the various concepts of materiality suitable to different classes of users of financial statements, together with an example both qualitative and quantitative elements of materiality that may influence the users before the publication of financial reports. The Practice Statement has described quantitative factors as being insufficient alone to formulate the materiality statement. Therefore, it is important to address the inconsistencies with the definition of materiality. Some additional and more practical recommendations that should be included in the Exposure Draft regarding material disclosure that would guide the thought process of preparer’s may include – Purchases of property, cash used in plant and equipment as investing activities of the cash flow statements (Rehwinkel and Gouws 2015). Additionally, exploratory capital and intellectual property investments could be discussed further in notes. Further, it would be beneficial if the examples are presented in a flow chart to enable the preparers of financial statements to undertake materiality review as the final exercise in completing the financial reports (Christian and Lüdenbach 2013).

Role of Proposed Exposure Draft in Assisting the Preparers of Financial Statements in Providing Useful Information

The practice statement would provide an opportunity for the users of financial statements to make more determined and informed information based on the financial reports. With the proper consideration of materiality, the preparers would be able to make better financial statements that would enable the users (shareholders, investors) to make quality decision and help in improving comparability among peer companies  (Picker et al. 2013). The concept of materiality needs application of judgement. As the proposed Practice Statement is a non-mandatory guidance, it will allow the users of financial statements to have better comprehend the concepts of materiality and its impact on the financial reports and investment decisions. The elements of measurable criteria in materiality such as – “quantitative thresholds”, “qualitative assumptions”, “key metrics”, would guarantee appropriate presentation of all materially relevant disclosures that would further assist the users of financial statements to make better financial decisions (Owen 2013). The Practice Statement aims at providing the users with greater assistance by providing consistency and comparability in financial statements across peer companies. In the absence of proper guidance and framework on what elements to be considered as materially important to be included in the financial statements, there is huge difference in the elements of materiality across the industry. Therefore, by providing a non-mandatory guidance the IASB aims at reducing the gap and provides end user a uniform platform to compare the financial statements and make relevant decision (Morris et al. 2013).  Although, the Practice Statements basically targets the prepares of financial statements to make them understand the concept  of materiality and its impact on the final financial reports, the users are also affected as the purpose of these financial statements is to inform the end-users to make financial decisions (Crawford and Power 2015). The proper identification of material elements would inform users of financial statements about the extent of investment outlays incurred in order to achieve the organizational performance goals. However, the proposed Practice Statements should suggest a method that requires certain decisive questions to be answered in order to establish the level of importance that should be given to a business transaction (Black and Maggina 2016).  The current practice statement does not provide a systematic and step-by-step approach in reaching dependable and comparable conclusions across the peer organizations. Material information and its impact on the stakeholders decisions is governed by the degree to which their decisions to “hold, buy or sell” their stake in the entity could be “confirmed, reinforced or altered”. These decisions are based on many elements such as earnings in context to future performance; total capital investments, cash burn rate of the entity, and other factors and materiality play a big role in it (Deegan 2013).

Role of Proposed Exposure Draft in Assisting the Preparers of Financial Statements in Making Economic Decisions

Conclusion

From the above discussion, it can be concluded that the current draft developed by IASB that provides guidance to the preparers and users of financial statements is a positive step towards enhancing the corporate reporting’s. From the feedback provided by the preparers and users of financial statements, it is clear that the concept of materiality in the financial reporting is widely disputed and subjective issue. Therefore, IASB has proposed the draft as a guidance principle that allows for subjective nature of materiality. The current proposal is holistic and provides outline for understanding the materiality in financial reporting and its impact on the decision making by the users of financial statements. The proposed draft would assist the preparers of financial statement to have better understanding of the material components that needs to be included in a financial report of an entity. On the other hand it also assists the users of financial statement to have a transparent and true representation of an entity’s financial conditions and also assists in comparability of financial statements among peer business organizations for making investment decisions.

References

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