IFRS Practice Statement 2: making materiality judgements

Should a company capitalise a ₦5,000 stapler and depreciate it over five years? Should it disclose a ₦2m commitment in the notes? The answer to both is: only if it matters to the people who read the statements. That idea is materiality. It decides what is recognised, how it is measured, what is shown and what is left out. It is the most used judgement in financial reporting.

This topic covers International Financial Reporting Standards (IFRS) Practice Statement 2 Making Materiality Judgements: its scope, the definition of material, why materiality judgements are everywhere, the primary users and their needs, quantitative and qualitative factors, the effect of public information and local law, and the four-step process. The previous topic covered management commentary. This is the last topic in the course.

Key terms in plain English

Syllabus check

IFRS Practice Statement 2 is examinable under syllabus area C. This topic covers:

• the scope of the practice statement;
• the general characteristics of materiality, including the four-step process.

CAMA 2020 and materiality

The Companies and Allied Matters Act 2020 (CAMA 2020) requires statements that follow International Financial Reporting Standards (IFRS) and give a true and fair view.

Scope

• It applies to general purpose statements prepared under IFRS. It is not meant for the IFRS for SMEs.
• It is non-mandatory guidance. An entity can claim IFRS compliance without applying it.
• Within IFRS, the definition of material comes from the Conceptual Framework (and International Accounting Standard (IAS) 1 has a similar definition): information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions of the primary users.

Materiality is everywhere

• Recognition and measurement: a requirement need only be applied if its effect is material. A policy such as expensing items below a threshold is acceptable if its effect is not material and it was not set to achieve a presentation. It is reassessed each year.
• Presentation and disclosure: a disclosure listed in a standard need not be given if the information is not material, even where the standard calls it a minimum. The opposite also applies: give extra information not listed in IFRS if users need it to understand the effect of transactions, events and conditions.
• The assessment is for the complete set of statements (primary statements and notes).
• It is wrong to make, or leave uncorrected, immaterial departures from IFRS to reach a particular result.

Primary users and their needs

• Primary users are existing and potential investors, lenders and other creditors. Do not narrow the information to what current investors, lenders or the parent want.
• They are assumed to have a reasonable knowledge of business and economics and to study the statements diligently.
• They make decisions about providing resources: buying, selling or holding shares and debt; giving or settling loans and credit; and using voting and other rights. These depend on expected returns, so they need information about resources, claims and changes in them and about how well management has used the resources (stewardship).
• Information may be material because it has predictive value, confirmatory value or both. The test is whether it could be expected to influence decisions, not whether it alone would change them.
• The statements meet the common information needs of users and not the special needs of one user. Identify the common needs within each of the three categories separately, and take them all together. Do not use only what is common to all three.
• Users also consult other sources, but the statements must be complete in themselves. Public availability of information does not relieve the entity of the duty to disclose material information.

Local law

• An entity that states IFRS compliance cannot give less information than IFRS requires, even if local law allows it.
• If local law requires information that is not material under IFRS, it may be given, but it must be organised so that it does not obscure material information.
• If information is material under IFRS but local law does not require it, it must still be given.

The four-step materiality process

1. Identify information that has the potential to be material. Start from the requirements of IFRS for the entity’s transactions, events and conditions, and add anything users need that is not listed. Cost of compliance is not a factor unless the standard allows it.
2. Assess whether it is in fact material, in the context of the statements as a whole.
   • Quantitative: the size of the effect against revenue, profit, financial position ratios and cash flow measures, including unrecognised items such as contingent liabilities. Do not rely on a uniform numerical threshold.
   • Qualitative: entity-specific factors (a related party, an uncommon feature, an unexpected change in trend) and external factors (the location, the industry or the economy). A single factor does not make an item material, but makes it more likely to matter. An immaterial amount may matter because of an unexpected change from last year. If an entity is not exposed to a risk that others in its industry face, that fact can be material.
3. Organise the material information so it is clear and concise: emphasise material matters; tailor it to the entity; keep it simple and direct; show relationships; use a suitable format (table or narrative); keep it comparable; avoid duplication; do not let immaterial information obscure material information; and do not combine material items of a different nature or function.
4. Review the draft statements as a whole. Items that are immaterial on their own may be material together. Check relationships, clarity and fair presentation. The review may add information, break out items, remove immaterial detail or reorganise. It may lead you to repeat Step 2.

Assessments from earlier periods can be relied on if they are reconsidered for changes in circumstances. The process is not meant to test materiality for local legal purposes.

The rules in more depth

Why not one threshold

A ₦10m item is trivial in one company and a crisis in another. A fixed percentage such as 5% of profit ignores the nature of the item. A small payment to a director matters because of who it went to.

Why cost is not a factor

The standard setter has already weighed the benefit against the cost when it wrote the requirement. An entity cannot use cost to decide that information is immaterial.

Why the statements must stand alone

A reader should not need a press release to understand the accounts. The statements are the complete, audited record.

Effect on analysis

Reading what a company leaves out is as useful as reading what it includes. Short notes may mean a simple business or may mean that important details are missing.

Worked examples

1. Quantitative:
   ₦18m ÷ ₦1,200m = 1.5% of profit
   ₦18m ÷ ₦20,000m = 0.09% of assets.
   Unlikely to influence users.
2. Qualitative: routine, low-value items, no related party, no unusual terms or sensitive area.
3. Conclusion: the policy is likely acceptable if it was not set to achieve a presentation, and it is reassessed each year, with the effect staying immaterial.
4. Document the reason for the threshold, the percentages, the qualitative review and the confirmation that it is not aimed at performance measures. Reassess if volumes, profit or the context change.

1. The line item does not make every IAS 16 disclosure automatic.
2. If the commitments are not material (size and no qualitative factor), the disclosure is not required.

1. IAS 36 does not require the assumptions used for recoverable amount in this case.
2. The assumptions on whether and when the regulations will be enacted could reasonably influence users’ decisions, because they affect the impairment.
3. So the entity discloses them although IFRS and local law do not require it.

1. The primary users are still existing and potential investors, lenders and other creditors.
2. The entity does not cut its disclosures to what the parent or the suppliers want. It also considers potential investors, lenders and creditors.

1. That need is not common to the users as a group.
2. The entity does not need to provide it, and treats it as immaterial for its primary users.

1. IFRS 3 requires disclosure of the primary reasons and how control was obtained.
2. The acquisition is material by size. The information is in the press release, but it must also be in the statements.

1. The entity may give the disclosure, because IFRS allows information required by local law.
2. It organises the notes so that the item does not obscure material information.

1. The related party and the terms are qualitative factors. The disposal is material under IFRS.
2. The entity discloses the details despite the lack of a local requirement.

1. Identify: the requirements of IFRS 3 (acquisition), IFRS 7, IFRS 9 and IAS 32 (refinancing) and the presentation rules for the restructuring.
2. Assess: the restructuring (5% of profit) is likely material by size. The acquisition is small by size but strategic, so material by nature. The refinancing changes the interest rate risk and future interest cost, so material by nature. All three need some disclosure.
3. Organise: balance the notes, tailor them, link the events to performance, position and risk, and cut detail in the restructuring note that adds length but not insight, while giving the acquisition and refinancing enough information (rationale, terms and the rate risk).
4. Review: stand back and ask whether users can see the effect of all three events together, and repeat the assessment if the combined effect needs more prominence.

How to score full marks

• Quote the definition: omitting, misstating or obscuring, reasonably expected to influence primary users.
• Say that it is entity-specific and depends on nature and size.
• Give both quantitative and qualitative reasons with percentages where the question gives figures.
• Name the primary users and say that potential users count.
• Say what the practice statement says about cost, public information, local law and extra disclosures where relevant.
• Use the four steps as headings when asked to apply the process.
• State that it is non-mandatory guidance.

Common mistakes in the exam

• Using only a percentage of profit as the test.
• Ignoring qualitative factors such as a related party.
• Saying that cost makes a disclosure immaterial.
• Treating existing users as the only primary users.
• Leaving out information because it is in a press release.
• Thinking local law can reduce IFRS disclosures.
• Forgetting to reassess each reporting date.

Quick revision

• Material: omitting, misstating or obscuring could reasonably influence primary users. Entity-specific.
• Applies to recognition, measurement, presentation and disclosure. Reassess each year.
• No uniform threshold. Quantitative and qualitative factors. Cost is not a factor.
• Public information and local law do not reduce IFRS disclosure. Immaterial local items must not obscure.
• Four steps: identify, assess, organise, review.
• CAMA 2020: ss. 377(1), 378, 379 to 381, 374(1), 385, 404(7).

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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