Materiality: financial reporting, sustainability reporting and integrated reporting

written by Carol Adams

Corporate reporting has seen significant changes in the last three decades with the increased globalisation of business and the accounting profession; the advent of the internet and then social media which have increased the impact of stakeholder activism. Perceptions about whom companies should be accountable to and on what issues have changed considerably and new approaches to materiality have emerged.

This article briefly discusses the evolution of the concept of materiality from the days when it was almost exclusively used by accountants in financial reporting, to its introduction to sustainability reporting through the AA1000 Standards, and later through the Global Reporting Initiative, to the recent work of the International Integrated Reporting Council (IIRC).

For the purposes of financial reporting materiality is an entity specific consideration (International Accounting Standards Board’s (IASB) Conceptual Framework, 2010 (pdf)) i.e. the wider organisational context is not relevant. International Accounting Standard (IAS) 8 (pdf) states that: “Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements.” Further, “the possible effect of misstatements on specific individual users, whose needs may vary widely, is not considered.” (International Standard on Auditing 320 (pdf)).

In contrast, the thinking on materiality in sustainability reporting developed through the AA1000 Standards and linked publications, whilst drawing heavily on the financial audit community, has been concerned with a much broader range of decisions, the broader context in which the organisation operates and corporate impacts on a broad range of stakeholders, including specific stakeholder groups. The publication of the AA1000 Framework (1999) was a catalyst for changing corporate practice.

The Materiality Report (2006) demonstrates the benefits of linking the materiality process with strategy development, performance management and creating value. Its Materiality Framework defines material issues as those that could make a major difference to an organisation’s performance. Quotes from leading organisations indicate that practice was already heading in the direction of integrating materiality in financial and sustainability reporting.

AA1000APS (2008) defines a material issue as one “that will influence the decisions, actions and performance of an organisation or its stakeholders”. In order to adhere to the principle of materiality an organisation needs to have a materiality determination process that is integrated into the organisation, considers issues from the perspectives of stakeholders, societal norms, financial considerations, peer-based norms and the broader sustainability context. It must include a method of addressing conflicts between expectations derived from these different sources.

The Materiality Background paper (pdf) for <IR> just released by the IIRC defines material issues as those which could “change the assessments of providers of financial capital with regard to the organization’s ability to create value”. (This seems to be a somewhat different emphasis from that in the Capitals Background Paper (pdf) which notes the interest of ‘other stakeholders’ in reported information.)

The Materiality Background paper emphasises the role of senior managers and Boards in the materiality process. Whilst highlighting Board responsibilities is a step forward, the lack of acknowledgement of the role of organisations depleting natural capital, for example, is a concern although the paper does say that determination of relevant matters should consider whether the matter “substantively affects, or has the potential to substantively affect, the organization’s strategy, its business model, or one or more of the capitals it uses or affects”. The importance of not overlooking long term matters is stressed. Stakeholders are mentioned in terms of their potential to impact on the ability of the organisation to create value – and not their concerns about organisations depleting value.

The IIRC is clearly calling for Boards and senior managers to shift their thinking more to the long term, to think beyond what can be measured in quantitative terms and to think about value creation in a broader range of ‘capitals’. This transition is important and will be challenging. It requires a significant shift in thinking. Stakeholder engagement is critical to challenging organisational thinking and making this change.

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