Proposed Changes to Materiality

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The AICPA’s Auditing Standards Board (ASB) recently released an exposure draft of a Statement on Auditing Standards (SAS)  and a Statement on Standards for Attestation Engagements (SSAE) that would align the AICPA definition of materiality with the definitions used by the United States judicial system, the PCAOB auditing standards, the FASB, and the U.S. Securities and Exchange Commission.

Currently Defined

The AICPA’s definition of materiality is described in SAS No. 122 (AU-C Section 320) as ‘Misstatements, including omissions, are considered to be material if, individually or in the aggregate, they could reasonably be expected to influence economic decisions of users that are taken based on the financial statements.’

Materiality is an established accounting convention, understood by all in the accounting profession.  However, there is a subjective element to materiality, because judgment is dependent upon the user of the information.  Materiality varies among users of the information based on their interests, motivations, and objectives.

Standards Affected

If issued, Amendments to the Description of the Concept of Materiality would amend Sections 200, 320, and 600 of SAS No. 122, Statements on Auditing Standards: Clarification and Recodification; SAS No. 134 Auditor Reporting and Amendments, Including Amendments Addressing Disclosures in the Audit of Financial Statements; and SAS No. 13X, Forming an Opinion and Reporting on Financial Statements of Employee Benefit Plans Subject to ERISA as well as Sections 205 and 210 of SSAE No. 18, Attestation Standards: Clarification and Recodification. 

Reasoning

The AICPA’s current definition of materiality is aligned with the definitions used by the International Accounting Standards Board (IASB) and the International Auditing and Assurance Standards Board (IAASB).  The ASB believes it is in the best interest of the public to further align the definition of materiality with the definition used other standard setters and regulators, including the U.S. judicial system, PCAOB auditing standards, FASB and the SEC.  The ASB wants to eliminate any inconsistencies between the definitions used by the various organizations.  FASB amended their definition of materiality in 2018 to align with the other regulating boards. 

Current Differences

The main difference between the definition used by the ASB/IASB/IAASB and the definition used by the other boards is the use of the words ‘could’ and ‘would’.  The ASB/IASB/IAASB consider a misstatement to be material based on whether the misstatement ‘could’ reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements.  The other standard setters and regulators define a misstatement as material if there is a substantial likelihood that a reasonable person ‘would’ consider it important.   influence the judgment of a reasonable investor. 

Proposed Revision

The latest definition, detailed earlier, would change to the following: ‘Misstatements, including omissions, are considered to be material if there is a substantial likelihood that, individually or in the aggregate, they would influence the judgment of a reasonable user made based on the financial statements.’ 

The ASB believes this alignment will provide consistency across standard setting and regulating agencies but should not significantly impact the current extent of work being performed using the definition.