Materiality and Disclosures: FASB Decides to Maintain the Status Quo

On March 21, the Financial Accounting Standards Board (FASB) abandoned plans to 1) amend the definition of “materiality” and 2) give businesses more discretion when determining what to include in their financial statement footnotes. These projects have officially been removed from the FASB’s active agenda ― for now.

Defining “materiality”

After many years of research and debate, the FASB decided to return to the concept of materiality outlined in Statement of Financial Accounting Concepts (CON) No. 2, Qualitative Characteristics of Accounting Information. CON No. 2 defines materiality in the context of “the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.”

The FASB said this tried-and-true definition aligns with the concept used by the Securities and Exchange Commission (SEC), Public Company Accounting Oversight Board (PCAOB) and American Institute of CPAs (AICPA).

“When it comes to defining materiality and providing guidance on how materiality should be applied in a set of given facts and circumstances, I don’t view that as our role,” FASB member Christine Botosan said. “That’s the role of practice, the courts, and auditors, and everyone else to figure that out.”

Addressing “disclosure overload”

The FASB started examining disclosures in 2009 amid complaints from businesses about too many disclosures in increasingly lengthy financial statements. However, it recently decided to abandon a controversial plan that would have updated Topic 235, Notes to Financial Statements, to help businesses determine when a piece of information is important enough to include in a footnote.

FASB members rejected the guidance from the September 2015 Proposed Accounting Standards Update (ASU) No. 2015-310, Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material, after investors said it would give companies too much leeway to exclude important information from their footnotes. At the same time, businesses concluded that the proposed changes wouldn’t help them reduce costs.

“What we found in our outreach over the years is that users do not suffer from overload; they have technological tools at their disposal,” said Nicholas Cappiello, the manager of the FASB staff’s work on the materiality of footnote disclosures. “The feedback we received was, they’re happy to get what they get.”

In the past, the term “disclosure overload” was coined to describe a plight that some financial reporting professionals believed forced investors to wade through excessive amounts of information in company financial statements. But securities analysts and portfolio managers rarely described themselves as having to contend with any sort of overload, and some said the FASB project was a solution in search of a problem.

Restart button?

This may not be the last we see of the disclosure project, however. FASB member Harold Monk believes that companies still have legitimate concerns about disclosures, and there still may be a need for the FASB to address the issue at another time.

“While users and user associations and investor groups may not be concerned with disclosure overload, millions of preparers and thousands of auditors are. They think it is a real problem, and one that needs to be dealt with,” Monk said.

Sidebar: Simplified guidance for lessors under new lease standard

The Financial Accounting Standards Board (FASB) recently approved some targeted improvements to its lease standard for landlords. These changes will allow certain lessors to combine the receipts from property leases and the service income associated with them. Examples of service charges include fees for cleaning, security and snow removal in common areas.

The FASB also decided that lessors would have to treat a lease contract as an operating lease in accordance with FASB Accounting Standards Codification (ASC) 842, Leases, if the service charges in the agreement are predominantly associated with the lease. But lessors would account for the contract using FASB ASC 606, Revenue from Contracts with Customers, if the lease component is smaller than the service charges associated with it.

Going forward, the FASB plans to propose another amendment to the lease standard that deals with other costs that lessors incur, such as sales and property taxes and insurance premiums.

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