Background-:

1. Recently, in October 2015, the International Accounting Standards Board (IASB) who are developing International Financial Reporting Standards [IFRS] has issued two draft documents namely

A. Application of Materiality to Financial Statements

B. Uncertainty over Income Tax Treatments

2. IFRS regime is meant for General Purpose Financial Statements. The aim of the above two draft documents are as follows

Application of Materiality to Financial Statements

3. The aim is to provide guidance to assist management in applying the concept of materiality in the following areas:

(a) characteristics of materiality;

(b) how to apply the concept of materiality when making decisions about presenting and disclosing information; and

(c) how to assess whether omissions and misstatements of information are material to the financial statements.

Uncertainty over Income Tax Treatments

4. To provide guidance in accounting for uncertainty over income tax treatments,

(a) whether an entity should consider uncertain tax treatments collectively;

(b) the assumptions an entity should make about the examination of tax treatments by taxation authorities;

(c) how an entity should determine taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates; and

(d) how an entity should consider changes in facts and circumstances.

Why this article-:

5. First of all, these two are different concepts and have been analysed in different documents.

Regarding Materiality.

6. As of today, there is no accounting standard on the important aspect of Materiality. Guidance is available under auditing standards which is meant for auditors. The concept of materiality is

  • pervasive to the financial statements and
  • is very much context based.

7. Though, both, the management and the auditor conceptually agree with the pervasiveness and contextual nature of the concept of materiality, the result is not the same when put to use.

8. It is so because there is a difference in the objective of management and that of the auditor. Both of them can not be equated.

9. There is a significant difference in application of the concept by management in preparation of financial statements and that by auditor whose aim is to verify whether there is a mis-statement which will influence the decision of the users of financial statements.

10. Thus an accounting standard on materiality is required. One may compare the position on related party transactions where there is an accounting standard and an auditing standard as well. It is so despite each of the governing laws have requirement for disclosure for related party transactions.

Regarding Unecrtainty over income tax treatment.

11. The accounting standard – Income taxes mainly emphasises the concept of accrual vis-à-vis concept of due. Thus the concept of deferred tax provision and consequentially the deferred tax asset and liability comes into picture.

12. It may be unclear how a specific requirement of the tax law applies to a particular transaction or circumstance. The acceptability of a particular tax treatment under the tax law might depend on the decisions taken by the relevant taxation authority or a court in future. Consequently, the outcome of examinations of a particular tax treatment by the relevant taxation authority or the outcome of a dispute may affect the entity’s accounting for a current or deferred tax liability or asset. For example, the taxable profit (tax loss) for the particular period may be affected by the results of a tax examination or dispute, the results of which are uncertain at the end of the entity’s reporting period.

13. But substantial uncertainty is there is estimating the ultimate outcome of the litigation of tax matters. The document has envisaged different situations which are routinely posed before the management and has proposed a solution for the same.

What one should look forward for

14. ISAB has requested suggestions on both the documents till Jan/feb-2016.

15. The document has been written keeping in view a participative approach. It means that, the document provides

  • Why IASB felt the need to prepare this document
  • Definition of concept / key terms
  • Principles arising out of concepts / key terms
  • Typical situations posed before the management
  • Examples / illustrations
  • Inputs are requested in an organised manner i.e. it has framed broad questions / areas / categories
  • Basis of conclusion

Regarding Materiality

16. Whether information is material is a matter of judgement that depends on the facts involved and the circumstances of the specific entity.

17. complete list of considerations for making judgements about materiality can not be prepared.

18. The concept of materiality is also intended to be applied as a filter to ensure that the financial statements are an effective and understandable summary of the information contained in an entity’s internal accounting records. If information in the financial statements is not summarised or aggregated in a clear and helpful manner, for example if an excessive amount of immaterial information is disclosed or material information is obscured or concealed, it makes the financial statements less understandable for users.

19. A specific term “primary users of financial statements has been used and elaborated.

20. Some examples of ways in which management can identify whether information is or is not useful to the primary users include:

  • users’ expectations, including how theythink the entity should be managed
  • information required by management itself for decision making observing users’ or market responses to information or
  • requests for information observing the types of information provided by entities operating in the same industry.

21. Qualitative and quantitative assessment of the concept of materiality

22. Examples in which considering quantitative aspects may not be helpful when making assessments about materiality include:

  • in deciding whether a particular accounting policy should be disclosed of uncertainties and contingencies, the monetary amounts involved are not always known
  • those that could trigger non-compliance with regulatory requirements or loan covenants;
  • those that could reasonably be expected to be key to the entity’s future operations, even if they do not have a material effect on the primary financial statements in the current period. An example would be part of the entity’s business that is currently relatively small but for which management are planning an expansion; or
  • rare or unusual transactions, for which management’s reasoning for undertaking the transactions could reasonably be expected to influence decisions made by the primary users. For example, a transaction may be unusual because it was on special terms with a related party of the entity.

23. While applying the concept of materiality, following aspects be taken into consideration

  • The assessment of materiality of an item should be undertaken at both, Individual and collective level.
  • A converse thereof – i.e. what is immaterial informtion should also be considered.
  • Providing immaterial information in the financial statements may obscure material information and consequently mean that the financial statements are less understandable
  • Aggregating and disaggregating information

24. An entity shall present separately

  • each material class of similar items.
  • items of a dissimilar nature or function unless they are immaterial

25. One may consider following example

if an entity has 500 similar leases of similar assets, then combining them together for disclosure purposes may not lead to a loss of material information. However, if a subset of those 500 leases has significantly different characteristics from the others (such as residual value guarantees or extension options), separate information about that subset may be material.

26. Application of concept and context of materiality for various components elaborated

  • Primary financial statements i.e. balance sheet, profit and loss account, cash flow statement and statement of change in equity versus the notes is defined.
  • potential perception of reader.
  • Disclosure requirements with co-relation with reuirements from other standards
  • Relevance to complete set of financial statements vis-à-vis interim reporting.
  • Impact on recognition and / or measurement of a financial item in the above context.

27. Various scenarios are identified when the results of application of the concept and context of materiality are applied and the results are other than as reported.

  • Identified misstatements
  • Current period misstatements
  • Prior period misstatements
  • Misstatements made intentionally to mislead

Regarding uncertainty over income tax matters

28. An entity should conclude on whether or not it is probable that a taxation authority will accept an uncertain tax treatment, or group of uncertain tax treatments.

29. If it concludes that the tax authorities will accept its position, it doesn’t pose much of the problems.

30. When it concludes otherwise, It shall reflect the effect by using one of the following methods:

  • The most likely amount—
  • The expected value—the sum of the probability-weighted amounts in a range of possible amounts

31. Needless to say, the above treatment must of used for both, current tax and deferred tax.

32. the entity should take into consideration the following aspects while determining above.

  • Time limit on taxation authorities’ power for examination(s)
  • Results of examination(s) by taxation authorities
  • Treatment of implicit acceptance
  • Explicit acceptance

Disclosures

33. An entity shall determine whether it should disclose following information about determining taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates

  • judgements made in the process of applying its accounting policy to determine taxable profit (tax loss),
  • information about the assumptions it makes and other estimates used in.
  • Consideration of changes in facts and circumstances

34. Accounting for interest and penalties is not within the scope of this [draft]

35. The Committee considered whether to also permit or to require the use of a ‘cumulative-probability approach’ (ie the measurement method used in US GAAP). It noted that the introduction of this method would make an entity’s judgements more complex.

36. This is because it would be more complex for an entity to determine the best among three methods (ie

  • Expected value,
  • most likely amount and
  • the measurement method used in US GAAP) than the better of two methods (ie expected value and most likely amount).

37. It also noted that no existing Standard in current IFRS uses the cumulative-probability approach, whereas the expected value and the most likely amount are commonly used in IFRS.

38. The links to the above mentioned documents are as follows

http://www.ifrs.org/current-projects/iasb-projects/disclosure-initiative/materiality/exposure-draft-october-2015/documents/ed_ifrspracticestatement_oct2015_website.pdf

http://www.ifrs.org/Current-Projects/IASB-Projects/IAS-12-Measurement-income-tax-uncertain-tax-position/Draft-Interpretation-October-2015/Documents/ED_IFRIC_UncertaintyOverIncomeTaxTreatments.pdf

( Author CA. Yogesh S. Limaye can be reached at yogesh@salcoca.com)

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