FASB is Living in a Materiality World
You’d be forgiven if you confused the Financial Accounting Standards Board’s (FASB) latest announcement about its “conceptual framework” for a description of an upcoming TED Talk. That kind of jargon is popular with thought leaders and thinkfluencers these days, but FASB is actually talking about the collection of principles that it applies to financial reporting requirements.
Specifically, late last month, FASB announced two changes to its conceptual framework. One deals with another potentially misleading term: “materiality.” Lucky for us, FASB is not discussing “materiality” as the matter of philosophy, metaphysics, or existentialism that it sounds like it could be. Instead, FASB uses “materiality” in the way that it is understood in the very real and practical world of Wall Street. There, it marks the dividing line between facts that public companies do not have to disclose to shareholders, and the (material) facts that they do.
According to FASB’s newly reformulated standard for materiality, “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.”
In reality, FASB just moved forward with a change that was already years in the making. The board harmonized its definition of materiality with those used by other key organizations in the financial ecosystem, including the Securities and Exchange Commission (SEC), the Public Company Accounting Oversight Board (PCAOB), the American Institute of Certified Public Accountants (AICPA) and the U.S. judicial system, including the Supreme Court. When the possibility of updating its definition of materiality was raised publicly, FASB received feedback from respondents indicating the changes were needed to “eliminate inconsistencies” with the other major governing bodies. It seems to have done that with its update.
In addition to settling the materiality issue, FASB added a new chapter to the conceptual framework that lays out what should be disclosed in the notes to companies’ financial statements.
An Ernst & Young study from 2012 revealed that the footnotes in 10-K MD&A sections had quadrupled over the preceding two decades, and both of the announced changes are aimed at reversing that trend of “disclosure overload.”
On top of its changes to those conceptual frameworks, FASB also issued two “accounting standards updates” (which no one is going to mistake for a TED Talk description). These, too, could be called attempts to right-size disclosure requirements for public companies. One updated the disclosure requirements for fair value measurements, while the other updated the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans.
Russell G. Golden, FASB’s chairman, characterized the updates as measures aimed at streamlining the financial reporting process. “The two changes to our Conceptual Framework will help the Board identify and evaluate disclosure requirements in accounting standards and clarify the concept of materiality,” he said. “Meanwhile, the new standards improve fair value and defined benefit disclosure requirements by removing disclosures that are not cost beneficial, clarifying disclosures’ specific requirements and adding relevant disclosure requirements.”
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