The concept of materiality is used to determine what’s important enough to be included in — and what can be omitted from — a financial statement. In late October, the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA) voted to finalize a revised definition of materiality in its professional standards.
Breaking away from international standards
Under current U.S. Generally Accepted Auditing Standards (GAAS), misstatements and omissions are considered material if they, individually or in the aggregate, could “reasonably be expected to influence the economic decisions of users made on the basis of the financial statements.” The current definition of materiality was set by the International Accounting Standards Board.
In June 2019, the AICPA issued Exposure Draft: Proposed Statement on Auditing Standards: Amendments to the Description of the Concept of Materiality. It proposed aligning the definition of materiality in the auditing standards with the definition that’s used in financial reporting under U.S. Generally Accepted Accounting Principles (GAAP).
Under existing GAAP, the amended definition of materiality is: “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.”
The proposal was approved during an ASB meeting in late October 2019.
“The ASB believes that eliminating inconsistencies between the AICPA standards and the definition of materiality used by the U.S. judicial system and other U.S. standard-setters and regulators is in the public interest,” said Ahava Goldman, associate director for audit and attest standards with the Association of International Certified Professional Accountants.
Conforming to FASB guidance
The ASB’s materiality project comes on the heels of the decision by the Financial Accounting Standards Board (FASB) to return to its original definition of materiality, which was in effect from 1980 until 2010. This definition differs from the international definition.
Under the ASB’s new definition, “Misstatements, including omissions, are considered to be material if, in light of surrounding circumstances, it is probable that the judgment of a reasonable person relying on the financial statements would be influenced or changed by the misstatements, individually or in the aggregate.”
“Because the revised [ASB] definition is aligned with the FASB [definition], the ASB believes it is substantially consistent with current firm practices with respect to determining and applying materiality in an audit or attest engagement and accordingly the amendments will not change practice, nor are they intended to,” Goldman said.
Setting the materiality threshold
This concept is one of the gray areas in auditing. No matter how materiality is defined in the auditing standards, there are no bright-line rules. Instead, auditors must rely on their professional judgment to determine what’s material for each company, based on its size, industry, internal controls, financial performance, and other factors.
Contact us at KraftCPAs to discuss the appropriate materiality threshold for your company’s financial reporting.