Refer to Materiality as a Legal Concept

• Published date: 01 January 2017
• Author: Bor‐Yi Tsay,Sean Chen
• Date: 01 January 2017
• DOI: http://doi.org/10.1002/jcaf.22249

55

© 2017 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22249

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Refer to Materiality as a

Legal Concept

Sean Chen and Bor-Yi Tsay

REFER TO

MATERIALITY AS A

LEGAL CONCEPT

Corporate man-

agement preparing

financial statements

must be faithful in

presenting the com-

pany’s true financial

or economic condi-

tions. However, the

underlying economic

condition often cov-

ers a huge volume

of facts that, in raw

data, would be over-

whelming to external

users. It is imperative

that summarized and

processed informa-

tion be presented in

a user-friendly man-

ner to help users

comprehend the big

picture of a business’s

financial health and

future prospects. To

achieve this goal, cor-

porate management

and accountants must

decide which types of

information are trivial

and should be summa-

rized and what other

types of information

are important and

cannot be condensed.

In essence, this is a

process of judging

the materiality of the

underlying informa-

tion. In short, cor-

porate management

bears an inherent

responsibility on its

materiality judgments.

The decisions on

materiality should be

made from the per-

spective of users of

financial statements

as prescribed in

FASB Concept State-

ments No. 8 (which

supersedes No. 1) and

No. 2. An inherent

discord can develop

if corporate man-

agement and users

do not think alike,

especially if they have

conflict of interest.

CURRENT

PRACTICES ON

MATERIALITY

Currently, only

auditing standards

The accounting profession traditionally regards materiality

assessment as the auditor’s professional judgment, which

is misleading. The Financial Accounting Standards Board’s

(FASB) concept statements emphasized that materiality

must be evaluated from the user’s perspective rather

than accountant’s. The Supreme Court of United States’

landmark case of Matrixx Inc. et al. Petitioners v. James

Siracusano et al. (2011) alerted the accounting profession

about the legal effect of accountants’ professional judg-

ment on materiality. The FASB, consequently, proposed

in a recent exposure draft to revise its concept statement

by adding “refer to materiality as a legal concept.” This

article analyzes the Supreme Court case to provide insight

into the Supreme Court’s reasoning and the impact of the

FASB’s intended concept statement on financial account-

ing and auditing. A simple interpretation of the Supreme

Court’s position is that materiality judgment should be

made from the user’s perspective rather than from the

preparer’s. Ultimately, the key issue is whether the pre-

parer presents financial statement faithfully.

If the FASB’s exposure draft is adopted, it will affect

management and auditors in different ways. When man-

agement doubts their judgment of materiality, they have

to gather sufficient evidence to substantiate the position

of immateriality. In other words, it is nice to say that “an

omission of immaterial information is not an accounting

error”; it is difficult to prove that the preparer has the cor-

rect interpretation of the investors’ view on materiality. A

lot of work on substantiating the evidence on immaterial-

ity is still required. On the other hand, auditors will have

to expand their work related to materiality assessment to

include the review of the client’s other formal or informal

statements and communications beyond the scope of a

traditional audit. © 2017 Wiley Periodicals, Inc.

Editorial Review