Research funding opportunity: Materiality – Financial Statements and Beyond

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By Marie Gardner, Head of Research

5 November 2021

Materiality: Financial Statements and Beyond.

About the call

Investors are the primary audience for financial reporting. However, when looking for references to materiality from a financial reporting lens, generally these disclosures are limited to the information in the auditor’s report that quantifies the materiality level, or levels, used by the auditor in forming their opinion. There is little in the way of information in the financial statements or the annual report about the process taken by management when determining their materiality level(s) and the levels applied when forming and reaching their assumptions and judgements.

Furthermore, increasingly other key stakeholder groups are looking towards an organisation’s entire annual report for matters beyond its financial performance and results. There is greater interest, across all key stakeholder groups (including investors), in an organisation’s environmental and social impacts as the sustainability/environment, social and governance (ESG) agenda gathers pace. This suggests that financial materiality might not be the only or the most appropriate basis for stakeholders’ decisions.

Materiality has become a much more complex issue as a result and new definitions and categories have emerged; for example, double materiality and nested materiality, to name but a few. There is currently some debate within the European Union (EU) and the International Financial Reporting Standards (IFRS) Foundation around whether the single materiality concept, which considers the impact on an organisation, or the double materiality concept, which also considers the impact of an organisation, should be applied to sustainability reporting. Many observers consider the single materiality approach to be too narrow a focus and have highlighted the misalignment between the IFRS Foundation position and that within the EU, as the Corporate Sustainability Reporting Directive  (CSRD) supports the double materiality approach, as did the Non-financial Reporting Directive (NFRD)  before it.

Call for research

Research proposals are therefore invited to consider relevant issues and understand more about the process and determination of materiality from a preparer’s perspective, as well as the information perception from users and other stakeholders. The term ‘users’ is very broad and ICAS invites proposals to define the perspective of what type(s) of stakeholders should be considered – for example categories of investors and shareholders (e.g. institutional vs retail, across different investment horizons and different strategies (active vs passive)), or other non-shareholder users such as, but not limited to, creditors, employees, activists and society.

The following questions are provided as examples of areas of interest to ICAS. They are for guidance only, without limitation and do not constitute a prescribed list to be addressed in proposals:

• Do users understand the different concepts of materiality and their impact (e.g. single materiality, double materiality, dynamic materiality, nested materiality)?
• Do users attach importance to materiality in their decision making and, if so, is there a gap in the information currently available/disclosed about materiality?
• What information would users like about the materiality process and level(s) used by management/preparers/auditors?
• What challenges exist in the determination and disclosure of materiality information by preparers, and in its interpretation and understanding by users?  What recommendations could be made to overcome the challenges identified?
• Considering the issues of cost vs benefit in producing this information, and of transparency vs volume of financial reporting, would this additional information / disclosure truly be of benefit to users?
• Could this additional information also be of benefit to wider stakeholders?
• For professional investors who typically hold portfolios covering companies reporting and being audited under both IFRS and US GAAP, what are the differences in the way financial materiality is fundamentally defined, audited and reported, and, to the extent that there are apparent differences, what impact does this have on making investment decisions?
• Does the quantitative threshold for materiality make it more likely that smaller errors or estimates in reported numbers, which could nonetheless be fundamental from an investor’s perspective, will not be evaluated for potential disclosure? For instance, even ‘zero’ could be material information for investors and other stakeholders despite not meeting the quantitative threshold for disclosure?  For example, climate risk not [yet] affecting a business’ financial performance can in itself be material information.
• Does evidence exist, to what extent and what are the implications for users and stakeholders, of discrepancies in interpretation of ‘materiality’ between financial and non-financial reporting? For example, the front half referring to a material risk despite no mention of it in the financial statement disclosures as being material.
• Is ‘materiality’ an out-moded term, established in financial and audit regulation, but now potentially too narrow to properly address the concerns and interests of wider stakeholders in terms of longer-term risks, intangibles not reflected in financial reports, ESG considerations, climate, etc.?
• Does a relatively narrow concept of regulated financial materiality provide an adequate basis for corporates and their auditors to address Brydon’s theme of ‘usefulness’ of information, including, where necessary, auditors providing original information to fulfil a reinforced public interest function?
• Rather than try to adapt the regulated concept of financial materiality to encompass wider non-financial, qualitative and informational matters, is there an argument for a new evaluative concept across both financial and non-financial information based on relevance, significance and ‘usefulness' to stakeholders?

Steering Group

The project will be overseen by an ICAS Steering Group which will work with the successful research team to finalise the parameters of the research. The Steering Group will support the research team throughout the duration of the project and will oversee the project on behalf of ICAS.

Outputs

A final draft of the report arising from the project is to be delivered by 31 October 2022 and the research team will also be required to make short presentations of interim and key findings to the ICAS Research and Corporate and Financial Reporting panels, and other relevant ICAS panels, boards or committees.  A presentation of findings at ICAS sponsored events may also be required.

ICAS encourages these required outputs to be supplemented by other more interactive and/or innovative delivery media, such as webinars, short videos, etc. following discussion and approval by the Steering Group. Publication in academic journals, following submission of the final report, is also encouraged.

It is essential that the research report should consider the public interest in these issues, and to draw conclusions, implications and formulate recommendations of interest to policymakers, regulators, members of the profession and wider stakeholders. These should be a maximum of 10,000 words in length.

Draft reports will be reviewed by the Steering Group, practitioner and academic reviewers, with a view to publication by ICAS.

Potential impact of project

ICAS will use the report arising from this call to inform public debate and policy development.

This project could help to influence the future direction of the discussions underway globally on the topic of materiality. Specifically, the findings from this research could inform the debate around the adoption of the single materiality concept by the IFRS Foundation and the soon to be established International Sustainability Standards Board (ISSB). This new Board is expected to issue an Exposure Draft of a Climate Change standard for public consultation in the first half of 2022; therefore, any research might help inform that consultation process and the final standard.

Funding

Grant funding is available up to a maximum of £15,000 per project. If any additional funding is required in excess of this amount, justification should be provided in the submitted proposal.

Proposals

If you are interested in undertaking a project in this area, please email research@icas.com attaching a call for research application form (available at icas.com) and a proposal together with summary CVs no later than 5pm on 17 January 2022. You should explain why you believe you or your team are suitable individuals to undertake the project, demonstrating your knowledge and experience in the area. You should specifically state how any team will be structured and responsibilities for completion of the report. The proposal should identify the specific topics identified in this flyer which you will focus on and include:

• details of the proposed research questions and methodology;
• a brief review of prior research/literature (academic and other), if any;
• how the project will advance current knowledge on the topic;
• the extent to which the research will be breaking new ground or building upon work which has already been undertaken;
• a summary of the key issues which you believe are likely to arise from the project;
• the anticipated impact and influence of the project; and
• the amount of grant, in sterling, which you require to complete the project and a breakdown of the estimated costs.

The Guidance Notes for Research Applicants explains what should be included in the proposal. ICAS welcomes all research methods, and applications are not restricted to the academic community and are accepted from around the globe.

The research proposals will be considered by the Steering Group and by a panel of academics and non-academics to arrive at a final decision. It may be that presentations will be required by shortlisted teams in order to reach a final decision. Dates for such presentations will be set at the mutual convenience of ICAS and the research teams. Applicants will be advised of the final decision by the end of March 2022.

For further information about this funding opportunity or any queries please contact the ICAS Research Centre:
Tel: +44(0)131 347 0100
Email: research@icas.com