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Prelims

Francesco Bellandi

Materiality in Financial Reporting

ISBN: 978-1-78743-737-1, eISBN: 978-1-78743-736-4

Publication date: 28 November 2017

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Bellandi, F. (2017), "Prelims", Materiality in Financial Reporting, Emerald Publishing Limited, Leeds, pp. i-xxix. https://doi.org/10.1108/978-1-78743-736-420171005

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Emerald Publishing Limited

Copyright © 2018 Emerald Publishing Limited

Half Title Page

MATERIALITY IN FINANCIAL REPORTING

An Integrative Perspective

Title Page

MATERIALITY IN FINANCIAL REPORTING

An Integrative Perspective

BY

FRANCESCO BELLANDI

United Kingdom – North America – Japan – India – Malaysia – China

Copyright Page

Emerald Publishing Limited

Howard House, Wagon Lane, Bingley BD16 1WA, UK

First edition 2018

Copyright © 2018 Emerald Publishing Limited

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ISBN: 978-1-78743-737-1 (Print)

ISBN: 978-1-78743-736-4 (Online)

ISBN: 978-1-78743-843-9 (Epub)

Dedication

To Anna, constant presence and support

List of Figures

Part II
Figure 1 Qualitative Characteristics under the IASB (1989) IASB Framework (reframed to compare with the FASB, 1985, CON 2). 12
Figure 2 Qualitative Characteristics under the Common Conceptual Framework (reframed to compare with the FASB, 1985, CON 2). 13
Figure 3 Qualitative Characteristics under the IPSAS Framework (reframed to compare with the FASB, 1985, CON 2). 14
Figure 4 Relevance and Materiality in FASB (1985), CON 2. 17
Figure 5 Relevance and Materiality in the IASB (1989), IASB Framework. 18
Figure 6 Relevance and Materiality in Integrated Reporting. 19
Figure 7 Reliability and Materiality in FASB (1985), CON 2. 22
Figure 8 Reliability and Materiality in the IASB (1989), IASB Framework. 23
Figure 9 Relationships between Materiality, Relevance, Completeness, and Reliability in FASB (1985), CON 2. 24
Figure 10 Relationships between Materiality, Relevance, Completeness, and Reliability in the IASB, 1989, IASB Framework. 25
Figure 11 Comparisons of Definitions of Materiality. 34
Part III
Figure 12 A Positive versus a Negative Concept of Materiality. 83
Figure 13 Graduation of Materiality. 85
Figure 14 Material Information in Users’ Decision Process. 87
Figure 15 Multiplying Risk-Level Graphs. 88
Figure 16 Decoupled Effect Risk-Level Graphs. 89
Figure 17 Single Effect Risk-Level Graphs. 89
Figure 18 Recognition versus Disclosure along the Likelihood Axis. 90
Figure 19 The Materiality/Disclosure Dilemma. 94
Figure 20 Possible Dimensions of Materiality. 96
Figure 21 The Flexibility Zone. 97
Figure 22 Eyes of Management versus Eyes of Investors. 98
Figure 23 The Ownership Triangle. 100
Figure 24 Materiality as a Planning Tool. 104
Figure 25 Consensus Materiality. 105
Part IV
Figure 26 IFRS Disaggregation or Aggregation Model for Presentation and Disclosure. 128
Figure 27 Materiality Dimensions for Disclosure. 137
Figure 28 Disclosure Based on Disclosure Relevance. 137
Figure 29 SEC’s 1987 Approach to Forward-Looking Disclosure. 146
Figure 30 SEC’s 1989 Approach to Known Trends or Uncertainties. 147
Figure 31 Classification of Assertions. 161
Figure 32 Relationship between Audit Risk and Materiality. 163
Figure 33 Examples of Effects of Materiality on Audit Risk. 164
Figure 34 Interaction of Materiality and Inherent Risk. 166
Figure 35 Second-guessing Management’s Determination of Users’ Needs. 167
Figure 36 How Materiality Affects Auditors’ Communication. 169
Figure 37 Effects of Materiality on Auditor’s Response to Fraud. 170
Figure 38 Effects of Materiality on Auditor’s Response to Illegal Acts. 171
Figure 39 Representation of Internal Control Deficiencies in Risk Maps. 174
Figure 40 Relationship between Risk Appetite and Risk Tolerance. 179
Figure 41 Interlock of Risk, Risk Appetite, Risk Tolerance, and Precision of Internal Controls. 179
Figure 42 Risk Tolerance as an Indirect Measure of Materiality. 181
Figure 43 Planned Materiality versus Risk Tolerance and Performance Materiality. 182
Figure 44 Precision of an Internal Control. 182
Figure 45 Inherently Imprecise Controls. 184
Figure 46 Role of Materiality in Testing ICOFR. 186
Part V
Figure 47 Small versus Large Misstatements Materiality. 221
Figure 48 Use of Performance Materiality to Assess Estimation Uncertainty. 222
Figure 49 The Use of Performance Materiality to Assess a Point Estimate. 223
Figure 50 Component versus Group Materiality. 229
Figure 51 Effect on the Details of Comparative Information of Corresponding versus Comparative Approach. 241
Figure 52 Disaggregation Based on the Corresponding Figure Approach. 242
Figure 53 Disaggregation Based on the Comparative Financial Statements Approach. 243
Figure 54 Materiality of Prior Period Misstatements. 247
Figure 55 Accumulation of Prior Period Errors in the Disclosure Initiative Tentative Model. 250
Figure 56 Risk of Material Misstatement of an Accounting Estimate. 254
Figure 57 Inherent Estimation Uncertainty. 255
Figure 58 Assessment of a Material Misstatement in an Estimation Range. 257
Figure 59 Assessment of a Material Misstatement in a Point Estimate. 257
Figure 60 Likelihood/Magnitude Mapping Applied to Reliability. 261
Figure 61 Summary of Treatment of Errors. 276
Figure 62 Effect on Materiality and Audit Risk of the Degree of Estimation of Interim Amounts. 282
Figure 63 Materiality Augmentation in Segment Reporting. 286
Part VI
Figure 64 Risk-Level Graph. 312
Figure 65 Significance/Influence Matrix. 316
Part VII
Figure 66 What Standards Say Users Want. 327
Figure 67 References to Materiality Triggering-Specific Actions. 343

About the Author

Francesco Bellandi, US CPA (Certified Public Accountant); CGMA (Certified Global Management Accountant); Dottore Commercialista (Italian Chartered Accountant); Diploma in International Financial Reporting from the ACCA (The Association of Chartered Certified Accountants, UK); Degree in Economics (summa cum laude), LUISS University; M.B.A., SDA Bocconi School of Business, Bocconi University; Diploma in Private Equity from the A.I.F.I. (Italy’s private equity association).

Francesco Bellandi is a practitioner in US GAAP/IFRSs dual reporting. Named by the AICPA as a worldwide IFRS US GAAP Subject Matter Expert, he is a member of the AICPA, the NYSSCPA (New York State Society of Certified Public Accountants), the NYSSCPA’s International Accounting & Auditing Committee where he has chaired the IFRS and the FASB subcommittees. He has been an Editorial Review Board Member of The CPA Journal, New York, USA.

Francesco Bellandi is a forensic auditor. He has served as a board director, chief financial officer, and finance director in several multinational companies around the globe and contract university professor in Audit and in IFRS.

He has authored several publications, including two books published by Wiley & Sons, 2012: The Handbook to IFRS Transition and to IFRS U.S. GAAP Dual Reporting and Dual Reporting for Equity and Other Comprehensive Income under IFRS and U.S. GAAP.

He can be reached at francesco_bellandi@yahoo.com or francesco.bellandi@dualgaap.com.

Preface

For financial statement neophytes, materiality looks like a philosophical issue, thought to be of little importance to practitioners and financial statements preparers adept to hard life. Yet, most of the internal management battles for what to filter through the internal reporting layers and what and how to disclose it in the external financial statements run on the verge of materiality.

Experienced financial statements preparers know that much of the discussion at the top management and board levels is on what to or not to present and disclose, justified on the grounds of materiality, but often for some other reason indeed. Auditors know that unless they can prove that a misstatement is material, their bullet would be smoothed. And if they did uncover something, they would pray that it was immaterial. Forensic analysts are aware that when a company says that something is not material, this alone is a good reason to investigate what this statement is trying to conceal.

Materiality is a slippery issue. Being so difficult and tricky, the FASB appears determined not to search for its definition in an accounting context. Standard-setters must serve a large audience, from preparers to investors. But preparers, indeed, are also among their stakeholders. They must find some trade-off: accounting is not for scientists and cannot be so difficult to be impossible or excessively costly. So, preparers push for materiality, invoking users, but really do users invoke materiality? Is this license too wide? It depends on how sophisticated the glasses of readers are, and from what angle they are viewing the scene. What could seem a departure from GAAP may in essence be acceptable as — somebody heard the auditor saying — it is not material. In a win-win situation, proving immateriality may give apparent relief to management for light sins and on the other hands be a useful defense to auditors. Investors, at least the most sophisticated of them, and financial analysts would rather have more information, because they know how to decide what is material to them. Securities regulators are obviously stricter than standard-setters.

Take it to the limit, somebody may have said after the fact, that it was too an immaterial issue to be of interest to users, and so this statement would be used to prove that before the fact there was an intent of fraud. The Court may have to say the last word.

This book offers an integrated perspective of materiality from the different angles of accounting standards for annual, interim, and segment reporting (including IFRS, US GAAP and SEC Rules and Regulations), auditing standards (including US and international ones), internal control over financial reporting, management commentary, financial analysis and management control, forensic analysis, sustainability reporting, corporate responsibility, assurance standards, integrated reporting, and limited legal considerations.

Part I introduces the background, including the scenario of the current debate as part of the IASB’s Disclosure Initiative, the FASB’s Disclosure Framework and the SEC’s Disclosure Effectiveness Initiative.

Part II contrasts the views of the accounting conceptual frameworks. It then compares the definition of materiality in different standards and contexts, to then draw a taxonomy of materiality and its attributes.

Part III reviews the uses and effects of materiality as an accounting, legal, audit, and managerial concept. It counterbalances the interests and positions of the various stakeholders involved, such as investors, preparers, standard-setters, auditors, regulators, financial analysts, and other users of the financial statements. It then capitalizes on the author’s vast experience in industry to devise alternative and complementary models of materiality with their pros and cons.

Part IV provides readers with interlinked guidance in accounting and audit about the extant requirements for the application of materiality to recognition, measurement, presentation and disclosure in the financial statements. It also expands to issues that are typical of management commentary. It informs about the complexities and subtle differences between financial statements and bookkeeping on the subject. Two full sections cover the application of materiality in auditing and in internal control over financial reporting, respectively.

Part V of the book goes into the details of how to assess materiality. It draws from a plethora of different disciplines to go to the essence of the very meaning and application of professional judgment and its multifaced aspects in specific scenarios and decisions. This section goes into practical guidance that rarely can be found on a such judgmental topic.

Part VI illustrates different approaches concerning the processes and methods that an entity can establish to determine materiality. Given the highly subjective nature of materiality assessments, proper processes, systems and methodologies are at the forefront of the recent and future developments in this area.

Part VII tackles specific issues of application of materiality. This section includes an illustration of SEC Staff comments on materiality in the review of Form 20-F of foreign private issuers and a checklist of specific accounting pronouncements relating to specific materiality decisions.

Part VIII of the book wraps up the whole content in showing how an experienced professional can handle discussions with management to uncover inappropriate schemes, manipulation tactics, if not frauds.

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