Paul Munter, the SEC’s acting chief accountant, issued a statement to address the concept of materiality and to express his views on the correction of material errors.
To provide investors with quality financial information, it’s essential they’re notified promptly whenever a material error is identified in previously issued financial statements.
An overview of the statement and its potential impact follows.
Objective Assessment of Materiality
The determination of whether an error is material is an objective assessment focused on if there’s a substantial likelihood it’s important to the reasonable investor.
Care must be taken when determining whether an error can be corrected through a revision in the current period, or if a full restatement of a prior period is required.
The objective assessment should be performed through the lens of the reasonable investor and take into consideration all relevant facts and circumstances surrounding the error, including both quantitative and qualitative factors.
The assessment should exclude any potential bias of the registrant, auditor, and audit committee.
Qualitative Versus Quantitative Factors
While a quantitively small error may be material because of qualitative factors, the statement highlights that, in comparison, it may be difficult to conclude that a quantitatively significant error is immaterial because of qualitative considerations.
Staff Accounting Bulletin 99 lists examples of qualitative circumstances that may affect the materiality of a quantitatively small misstatement.
However, this isn’t an exhaustive list and different qualitative factors may be more applicable when evaluating whether a quantitatively significant error is qualitatively immaterial to a prior period.
As the quantitative magnitude of the error increases, it becomes increasingly difficult for qualitative factors to overcome the quantitative significance of the error.
Additional Considerations
The statement also addresses other considerations and emphasizes the:
- Impact on US generally accepted accounting principles (GAAP) numbers
- Need to consider each error individually before any aggregation
- Impact on management’s assessment of the effectiveness of internal control over financial reporting when an accounting error has been identified
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For more information on how the statement on materiality may affect your business, contact your Moss Adams professional.