(i) Information is material if omitting it or misstating it could influence decisions which users make on the basis of financial information about a specific reporting entity. Materiality is an entity-specific aspect of relevance, based on the nature and/or magnitude of the items to which it relates in the context of the entity’s financial report. It is therefore difficult to specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation. Materiality should ensure that relevant information is not omitted or mis-stated and it should help filter out obscure information which is not useful to users of financial statements.

The Conceptual Framework describes materiality as an application of relevance by a particular entity. When an entity is assessing materiality, it is assessing whether the information is relevant to the readers of its own financial statements. Information relevant for one entity might not be as relevant for another entity. IAS 1 Presentation of Financial Statements says that an entity need not provide a specific disclosure required by an IFRS if the information is not material and that the application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements which achieve a fair presentation. In other words, material information must be disclosed irrespective of whether there is an explicit disclosure requirement.

Although preparers may understand the concept of materiality, they may be less certain about how it should be applied. Preparers may be reluctant to filter out information which is not relevant to users as auditors and regulators may challenge their reasons for the omissions. The way in which some IFRSs are drafted suggests that their specific requirements override the general statement in IAS 1 that an entity need not provide information which is not material. Standards are often complied with rigidly which leads to ‘boiler plate’ disclosures. Regulators are not keen to encourage the use of judgement but rather wish compliance with IFRS. If the concept of materiality was applied successfully, then immaterial information would be removed and the performance and the position of the entity would be more visible. Investors require better, more relevant, material information. The time and resources available in a reporting cycle may mean that many preparers are not capable or willing to make a materiality judgement. Regulators are often unwilling to apply a principle-based view, and are often quick to raise a query when a disclosure has been removed or not included.

Accounting policy disclosures often repeat information which was contained in IFRS and are not entity-specific. Information outside of financial statements cannot be policed and often key information is given in corporate presentations or outside the financial statements, which reinforces the perception that financial statements are a compliance document.

(ii) Integrated reporting (IR) takes a broader view of business reporting, emphasising the need for entities to provide information to help investors assess the sustainability of their business model. IR is a process which results in communication, through the integrated report, about value creation over time. An integrated report is a concise communication about how an organisation’s strategy, governance, performance and prospects lead to the creation of value over the short, medium and long term. The materiality definition for IR purposes would consider that material matters are those which are of such relevance and importance that they could substantively influence the assessments of the intended report users. In the case of IR, relevant matters are those which affect or have the potential to affect the organisation’s ability to create value over time. For financial reporting purposes, the nature or extent of an omission or misstatement in the organisation’s financial statements determines relevance. Matters which are considered material for financial reporting purposes, or for other forms of reporting, may also be material for IR purposes if they are of such relevance and importance that they could change the assessments of providers of financial capital with regard to the organisation’s ability to create value. Another feature of materiality for IR purposes is that the definition emphasises the involvement of senior management and those charged with governance in the materiality determination process in order for the organisation to determine how best to disclose its value creation development in a meaningful and transparent way.

(iii) IAS 7 Statement of Cash Flows was first published in 1992 and has been barely changed since that date. However, there are issues with the current standard. For example, cash flows from the same transaction may be classified differently. A loan repayment would see the interest classified as operating or financing activities, whereas the principal will be classified as a financing activity. The operating activities in the cash flow statement can be presented in one of two ways: the direct method and the indirect method. The direct method is seldom used as it displays major classes of gross cash receipts and payments. Companies’ systems often do not collect this type of data in an easily accessible form. The indirect method is more commonly used to present operating activities. The presentation of operating profit under the indirect method of the cash flow statement can start with either profit or loss before or after tax. A user’s ability to make comparisons may be affected if entities present reconciliations with different starting points. There are concerns over the current classification of items in the statement of cash flows. For example, dividends and interest paid can be classified as either operating or financing activities. As a result, users have to make appropriate adjustments when comparing different entities, particularly when calculating free cash flow for valuation purposes. Additionally, when a user is assessing an entity’s ability to service debt, interest paid would be reclassified from operating activities to financing activities.

Research expenditure is classified as cash from operating activities but is often considered to be a long-term investment. Some argue that such cash outflows should be included within investing activities, because they relate to items, which are intended to generate future income and cash flows. IAS 7 takes the view that, to be classified as an investing cash outflow, the expenditure must result in an asset being recognised in the statement of financial position.

Some items of property, plant and equipment are purchased from suppliers on similar credit terms to those for inventory and for amounts payable to other creditors. As a result, transactions for property, plant and equipment may be incorrectly included within changes in accounts payable for operating items. Consequently, unless payments for property, plant and equipment are separated from other payments related to operating activities, they can be allocated incorrectly to operating activities.

There are currently different views as to how to show lessee cash flows in the statement of cash flows. Some users would like the statement of cash flows to reflect lessee cash outflows in a way which is comparable to those of a financed purchase where the entity buys an asset and separately finances the purchase. Other users take the view that lease cash payments are similar in nature to capital expenditure and should be classified within investing activities in the statement of cash flows. Finally, there is concern about the current lack of comparability under IFRS because of the choice of treatment currently allowed. A lessee can classify interest payments within operating activities or within financing activities.

Partly as a result of the above practices, the IASB has published an Exposure Draft (ED), which proposes amendments to IAS 7. The main objective of the ED is to improve information about changes in an entity’s liabilities which relate to financing activities and the availability of cash and cash equivalents including any restrictions on their use. The ED results from the IASB’s Disclosure Initiative, which comprises several smaller projects to improve presentation and disclosure requirements in existing IFRSs. The proposed amendments would require an entity to provide a reconciliation of the opening and closing amounts in the statement of financial position for each liability for which cash flows are classified as financing activities. The proposed changes will require companies to reconcile the movement in debt from one period to another and together with the existing information from the statement of cash flows; this will facilitate net debt reconciliation.

Because many entities already voluntarily disclose a net debt reconciliation, the proposed changes should theoretically not impose any additional burden on issuers. The proposed amendments also require issuers to provide information to help users better understand any liquidity issues. The understanding of limitations on the use of liquid resource is important and some users would like additional disclosures to better understand the different types of debt financing by the entity. The changes should help users in making investment decisions.

Notes to the statement of cash flows (direct method and indirect method)
Components of financing activities (excluding equity) $ million
Sanchera, a listed company, has prepared a statement of cash flows for the year ended 31 August 2016. In financing activities, it has shown an increase in long-term borrowings to $140 million and an increase in the capital element of finance lease liabilities to $17 million.