While the widening scope of corporate reporting and assurance is making the concept of materiality more important, it is also becoming more complex.
While there is much talk – and even growing understanding – of the new world of corporate reporting and assurance, the concept of materiality in this emerging paradigm remains in need of clarification.
Materiality is a term understood, if not easily explained, by the auditors of financial statements, and either misunderstood or ignored by users. In terms of newer forms of reporting – such as integrated reporting and sustainability reporting, with their different purposes and audiences – the concept of materiality can be seen as a key driver.
David York, head of auditing practice at ACCA, says: ‘These days materiality is actually what is driving the newer reporting. The whole concept is becoming a question of what are the boundaries on which you are reporting.’ He suggests that if a company is reporting on sustainability, users are not interested in the traditional idea of just reporting on the assets and liabilities legally owned. ‘Users are interested in the influence a company has on its supply chain,’ he says. ‘They don’t care about ownership.’
Materiality means relevance as much as it does value. Sustainability reporting lacks the clear primary user group of financial reporting, so deciding what is included and what is not is problematic.
Carol Adams, the Australian-based founding director of Integrated Horizons, says that attention does need to be paid to materiality in this context. Adams, a member of ACCA’s Global Forum on Sustainability, says: ‘Materiality is important. While an integrated report might only include what is material to providers of finance, it is important that organisations report on and are accountable for material impacts on a broader range of stakeholders – either in an integrated report, on the website or in a publicly available special purpose report. Not to do so exposes the organisation to risk.
‘The accountant of the future will need an understanding of how all capitals impact on risk and ability to meet strategy. The outcome of an integrated and a sustainability report depends on a robust materiality process. This will present a challenge for assurance providers.’
Assurance providers could argue that the track record suggests that they are more than capable of rising to these challenges. But how far will they have to move? Richard Martin, head of corporate reporting at ACCA, suggests that maybe not that much needs to alter. ‘The issue needs to be thought through as a result of widening reporting, but people have to make a decision about what they include and what they don’t. In accounting and corporate reporting there is a clear audience of investor/shareholders and analysts. But it is still understood that what is material to one group may not be material to another,’ he says.
It has always been accepted that materiality is not just about the monetary size or value of the item. Martin says that this is a starting point but the definition is more focused on items whose inclusion or omission would alter the view of the user. Materiality has the power to tip a message one way or another. Integrated reporting accepts that some things that are important will not be easy to quantify through numerical indicators. (Want to put a value on employee skills and attitudes?)
Then there is the further challenge of comparing very different forms and sources of capital through the medium of money. Even when a figure can be produced, it is difficult to communicate the assumptions that need to be understood to put the quantification in context.
Adams is in no doubt of the challenges facing the assurance profession. She says: ‘The key issues for accountants are that integrated reporting aims to get us thinking longer term: thinking about creating value in terms of people, the natural environment, relationships – the ‘capitals’ – as well as increasing financial wealth and thinking about the business model in broader terms. With core skills in systems, processes, measurement and reporting, accountants will need to work with other functions to devise new ways of describing and measuring flows between the various capitals and thinking about how they are impacted upon.
‘Working out what it is about your people, relationships and environmental measures that add value to your business is important for long-term success,’ she adds. ‘Understanding how environmental impacts can affect reputation and financial risk, for example, makes good business sense. Accountants will need to think more broadly about what causes risk.’
Assurance and reporting have to meet those key challenges of providing the data stakeholders require, while still being able to show what is important to driving the success of the organisation. Materiality is central to determining whether those challenges are met.
It is worth recalling that materiality has always caused headaches for auditors. Dr Ian Dennis, a senior lecturer in accounting and finance at Oxford Brookes University Business School, is currently working on a project funded by ACCA that considers professional judgment in auditing. One of the preliminary conclusions of his work is that ‘auditors need to engage in further debate about what they want from the development of a concept of materiality before progress can be made in agreeing on the concept’. Dennis notes that given its importance in auditing, it is strange how materiality has been described as a black box and auditing’s ‘best-kept secret’. The new forms of corporate reporting and assurance may help to unlock that secret.
Peter Williams, accountant and journalist
This article first appeared in ACCA's Accountancy Futures journal, issue 7, August 2013.