Materiality in SSARS 19

SSARS 19 says misstatements are material when they could influence the economic decisions of users who are reading the financial statements.  If errors or misstatements in financial statements accumulate to the point where it could change decision-making, then you are in the range of material.  If there is something missing that should be present and it would change someone’s actions, that something is material. 

Let’s look at the flip side of this idea.  If there is something missing and nobody cares or would change their decisions if the information was present, then it isn’t material.  Might be better to avoid pushing this particular idea too far, because it could lead you down a slippery slope.  Picture the rationalization – “nobody reading these financial statements will have a clue about capital leases so I’m not going to bother seeing if any of them should be capitalized”.  Or, “there isn’t anyone that will ever see this footnote that has any idea what levels 1, 2, and 3 are in the fair value rules, so let’s blow off the fair value disclosures”.  Not a good idea to go there.

A second major point made by SSARS 19 is that evaluations or judgments on what is material depend on the context of the financial statements, which would include size of the organization and nature of the organization.  From this, you can see the quantitative and qualitative aspect of materiality.  A number may not be large, but if it turns a small profit into a small loss and that in turn violates a loan covenant, it is material. 

If the number is huge, but the organization is already doing wonderfully well or astoundingly terrible and that large number would not change the overall picture of the organization, then the item is probably not material.  Sometimes that is hard to get a hold of that idea.  At one time in the distant past I was a staff person on the audit of a large bank.  Right before the financial statements were released, the audit team discovered a big oopsie that would have reduced net income by a big number.  The audit team thought it was a very material item.  The partner disposed of the adjustment by concluding that it was such an incredibly good year otherwise that nobody would care that was only a slightly-less-than-incredibly good year.  Thus, the big oopsie was not material.

Another valuable point made by SSARS 19 is that materiality is based on what groups of users need and not what one particular user needs.  If one specific creditor really, really wants to see a particular piece of information and would change their decision based on that piece of information, the information is not material.  If one foundation would have withheld their funding if they knew one piece of information, that information is not material.  If there are a bunch of banks with loans, an error or missing disclosure does not become material just because one of the banks really wanted to see that information.

The danger in this last point, I suppose, is if you only have one bank providing financing then that one bank is probably the ‘group’ of users which materiality decision should be made.

Next post – going concern

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