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FASB’s Proposed Materiality “Clarifications” are Backfiring

Something must have happened between my post criticizing the FASB’s proposals to reduce materiality to a legal exercise and last week’s meeting of the SEC Investor Advisory Committee.  Just prior to the meeting, discussion of the proposals became an agenda item. Apparently, Chair White, dispatched Chief Accountant James Schnurr to engage in damage control.

According to the press coverage of the meeting, Mr. Schnurr was not successful.  Francine McKenna wrote a fairly restrained account for Market Watch, while David Dayen in Naked Capitalism was more strident. Both articles left the distinct impression that IAC members were as I, adamant that investors were being given the short end of the stick.

I wish I could have been at the meeting to see for myself how the SEC staff handled the criticism. However, one observer kindly shared practically verbatim notes with me.  With the caveat that they are by no means an official transcript, I will provide my reactions to selected portions of Mr. Schnurr’s remarks.

“In terms of the proposed changes that’s made, I think it’s important that because the proposal is out for comment right now, as a matter of practice it would really not be appropriate for me to talk about what my views are whether I support or not support it. I don’t want to poison the well, with respect to others commenting on this.” 

Really?  The probability that Mr. Schnurr isn’t fully supportive of the FASB proposals is essentially zero.  The FASB has functioned for its entire existence without providing a shred of practical guidance re materiality.  It was a topic left entirely to the SEC and auditing standards setters.  Hence, it strains credibility that Mr. Schnurr didn’t provide at least some initial direction to the FASB.  Otherwise, why would the FASB want to be sticking its nose in the PCAOB’s business?*

A plausible answer is that the SEC is using the FASB to blunt recent PCAOB pronouncements, which by the way had been unanimously ratified by the SEC. The PCAOB’s AS 14 calls for auditors to (1) accumulate uncorrected errors (see ¶¶ 10 – 14), unless clearly trivial (i.e., an amount well below immaterial); (2) to evaluate the accumulated errors (whether a B/S or P&L amount, or a disclosure); and (3) to share them with management. Appendix B sets forth a list (even more extensive than SAB 99 of qualitative factors to be considered in making a materiality assessment.  Hence, the PCAOB seems to be providing the appropriate guidance applicable to all of the disclosures covered by the auditor’s report — i.e., not just financial statement numbers directly addressed in SAB 99.

AS 16, in turn, requires the auditor to share its schedule of unadjusted differences, compiled in accordance with AS 14, with the audit committee (see AS 16 ¶¶ 18 – 19). The FASB proposal would take the audit committee out of the equation in evaluating aggregated immaterial disclosures if they are specifically designated as not “accounting errors” because they are immaterial. In effect, the proposal renders ¶19 of AS 16 inoperable for disclosures.

That’s what I mean about the FASB sticking its nose in the PCAOB’s business.  Who would believe that is possible without the Mr. Schnurr first clearing the way?

“ … [T]here’s been some disagreement about, for example, about if a company decided to omit what appear to be a required disclosure. So let’s take an example, if you have a defined benefit pension plan, there are list of items that are required to be disclosed. If a company has a single pension plan that was clearly not material to the financial statements of that company on a consolidated basis, and the company decided to omit that, there has been a question about whether or not that is “an error” and that has to be one of the requirements is you have to communicate that to the audit committee. Audit committee gets that info, and they say, ‘why are you telling me this?’  ‘You should tell me the whole thing is not material, so why are you wasting my time, why are you wasting management’s time putting that information and it’s not important to investors.’  So that is one aspect of the feedback the FASB is getting in trying to move forward with that.

The aspect in the proposal is that management will have the discretion to evaluate disclosures, and if they are not material, they could omit them, and that would not be considered an error. That’s essentially one of the aspects of the proposal.”

I think it safe to assume that Mr. Schnurr pulled out all the stops for the IAC.  And despite that, it seems that it persuaded nary a one to view the proposals more kindly.  That’s because nobody on the IAC was born yesterday.

Indeed, the PCAOB’s requirements were established in good faith (and ratified by the SEC) to serve investors who welcome safeguards against management abuses.   Specifically, except for matters that are clearly trivial, if management does not want to follow authoritative GAAP, it is incumbent upon them to make the audit committee aware of their decision, and to explain why the item is immaterial. Evidently, without any supporting evidence other than a few carefully selected anecdotes from self-interested parties, Mr. Schnurr has concluded that management is overly burdened by the PCAOB’s rules; that the entire process is a waste of time and money.  Mr. Schnurr believes that management should have the discretion to omit disclosures without consulting its board, and be subject only to the blessing of the company’s putatively “independent” auditor.

“… [T]he backdrop of the bigger [FASB and SEC] disclosure effectiveness [initiative] is that there are a number of constituents have complained about there is too much extraneous information that’s not material in there, and it skewers [sic] what’s really important. That’s part of the thrust of going forward with this.” 

Like virtually all members of the Accounting Establishment who have risen to the top of its ranks, Mr. Schnurr has developed an ability to tune out inconvenient feedback from investors.  As Damon Silvers, associate general counsel for the AFL-CIO, said at the IAC meeting, “more disclosure is better than less in general.”  I say that if investors are to get fewer disclosures, they should get better ones in return: like comprehensive detailed reconciliations of balance sheet captions.

The fact  that [the FASB is] saying it is a legal concept – it is actually consistent with the way it’s applied today.

The reactions of the IAC members strongly suggest that they perceive these proposals as threatening to lower the overall quality of disclosures.  As I explained in my previous post on this topic, this is the first time the FASB has ever attempted to make a real distinction between the concepts of relevance and materiality.  If any clarification were appropriate it should have been to inform practice that materiality determinations are to be made with the goal of producing a fair presentation. It is not merely a legal exercise.

“I can tell you from my own 40 years of experience in the profession, the attorneys are not involved in any significant way in the determination of whether something is material.”

Mr. Schnurr would have us believe that if materiality were officially reduced to a legal exercise, preparers and auditors would not rely on lawyers for making materiality determinations.

Gimme a break.


*I am a member of the PCAOB Standing Advisory Group.  The opinions expressed in this post are my own.

1 Comment

  1. Reply Mark December 28, 2015


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