Four years ago, the International Accounting Standards Board (IASB) amended its definition of ‘material’ because stakeholders had concerns about how companies made materiality judgements that determined which information should be included in financial statements.
The board had previously said omissions or misstatements of items were material ‘if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements’.
Here is the current definition: ‘Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.’
Although subtle, these changes were deemed necessary and consequential. It underlines the importance of materiality as an accounting concept.
Materiality is like a sieve that separates the reported from the omitted
Hot topic
But few things stay exactly the same for long in the accountant’s professional milieu. Materiality is again a hot topic. More precisely, it is a hot subtopic within the increasingly lively and urgent conversations about sustainability reporting.
Three major developments in little more than a month in 2022 have given us plenty of details of the likely shape and direction of sustainability reporting in the near future.
In March, the US Securities and Exchange Commission (SEC) proposed rule changes that would require certain companies to provide climate-related information in their registration statements and annual reports. For example, financial statements will have to include disclosures on climate-related financial risks and metrics.
Ten days later, the International Sustainability Standards Board (ISSB) released exposure drafts for its first two proposed standards. And the following month the European Financial Reporting Advisory Group (Efrag) launched a public consultation on the first set of draft sustainability reporting standards for the EU.
Fuzzy won’t cut it
Materiality is just as crucial in sustainability reporting as it is in financial reporting. It is like a sieve that separates the reported from the omitted, or a lens that sharpens focus on what really matters in decision-making. Either way, for materiality to work well in sustainability reporting, the intent and scope must be crystal clear, so its definition needs to be precise.
Trouble is, there is a range of views and interests about what constitutes material information in this context. Some positions are in direct opposition to each other. It takes time to establish a middle ground, yet the climate crisis keeps jolting us with alarming reminders that the clock is ticking.
A huge sticking point is whether double materiality should be incorporated right away in sustainability reporting across the world. In sustainability reporting, materiality is the effect of climate change on finance and corporate activities, whereas double materiality also covers the effect of finance and corporate activities on climate change.
Finance focus
To understand financial materiality, the IASB’s definition is a natural starting point. In fact, the ISSB built on that when drafting its standards. After all, both boards are under the umbrella of the International Financial Reporting Standards Foundation.
This is why the ISSB has explained materiality in familiar terms: ‘Sustainability-related financial information is material if omitting, misstating or obscuring that information could reasonably be expected to influence decisions that the primary users of general purpose financial reporting make on the basis of that reporting, which provides information about a specific reporting entity.’
The definition is a reflection of the ISSB’s objective of helping the primary users of reports – identified as investors, lenders and other creditors – to assess an entity’s enterprise value.
Because the SEC regulates the US capital market, its take on materiality addresses the needs of a more specific section of users. A matter is material, says the SEC, ‘if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote’.
Sustainability reporting that takes only financial materiality into account is inadequate
Double preference
The EU believes in going broader. It wants companies to report sustainability matters on the basis of the double materiality principle.
Efrag’s sustainability reporting standards require a company to ‘report the material information necessary to allow users of its sustainability report to understand its impacts on sustainability matters, and how sustainability matters affect the company’s development, performance and position.’
Efrag says a sustainability matter is material from an impact perspective if it is connected to actual or potential significant impacts by the company on people or the environment over the short, medium or long term.
Many people and organisations are with the EU on this aspect; they are convinced that sustainability reporting that takes only financial materiality into account is inadequate. The larger point is that when sustainability reporting rules do not harmonise on pivotal issues, their usefulness is diluted.
Nobody pretends that impact materiality is simple to assess and report. For that matter, materiality in financial reporting can still be slippery.
There is no straight and smooth path to a future of peace and prosperity for all. The world needs standard-setters, regulators, accountants, auditors, businesses, civil society and other stakeholders to diligently bridge gaps and find commonalities so that sustainability reporting can soon support the sustainability agenda.
