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TAC Public Meeting July 2024 Paper 2: Materiality
Executive summary
| Date | 15 July 2024 |
| Paper reference | 2024-TAC-009 |
| Project | Technical assessment of IFRS S1 and IFRS S2 |
| Topic | Materiality |
Objective of the paper
This paper presents an analysis for consideration by the TAC of the materiality provisions in IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1). This paper addresses the definition and application of materiality, interoperability, and how materiality may affect the location of disclosures.
The sources of guidance that may be used to identify disclosures is out of scope for this paper.
Decisions for the TAC
The TAC is asked to tentatively decide:
- to maintain the provisions in IFRS S1 relating to materiality; and
- in its role of providing a focal point for UK stakeholders to influence the ISSB, to:
- monitor the development of educational material on materiality by the ISSB;
- support the ISSB's work on interoperability; and
- ensure the views of UK stakeholders regarding materiality are communicated to the ISSB as part of the development of any future IFRS Sustainability Disclosure Standards.
Appendices
There are no appendices to this paper.
Context
1 IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) sets out the requirements for the appropriate disclosure of 'material information.' The relevant references to the requirements in IFRS S1 are as follows:
- Paragraphs 17–19 Materiality
- Paragraphs B13–B18 Materiality (17-19)
- Paragraphs B19–B28 Identifying material information
2 IFRS S1 defines material information as 'information is material if omitting, misstating or obscuring that information could reasonably be expected to influence decisions that primary users of general purpose financial reports make on the basis of those reports.'
This definition is aligned with the definition of materiality that is used for IFRS Accounting Standards. Paragraph 2.11 of the IFRS Conceptual Framework states that 'information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial reports make on the basis of those reports, which provide financial information about a specific reporting entity.'
3 IFRS S1 provides guidance on the identification of material information. In identifying material information, IFRS S1 requires entities to, in the first instance, refer to the IFRS Sustainability Disclosure Standard that specifically applies to the relevant sustainability-related risk or opportunity. If there is no specific IFRS Sustainability Disclosure Standard then entities should look to the requirements on sources of guidance set out in IFRS S1 paragraphs 57–58.
Endorsement criteria
4 The endorsement criteria applied in the analysis of this technical area include whether:
- use of the IFRS Sustainability Disclosure Standard is likely to result in an improvement in the international comparability of sustainability-related reporting in the UK;
- use of the IFRS Sustainability Disclosure Standard is likely to support companies in making disclosures that are understandable, relevant, reliable and comparable;
- use of the IFRS Sustainability Disclosure Standard is likely to improve the quality of corporate reporting within the UK in the long-term; and
- companies are likely to be able to provide the disclosures required by the IFRS Sustainability Disclosure Standard within the timeframes that a company normally reports without undue cost or effort.
Analysis
5 In relation to materiality, there are three matters for the TAC to discuss, including:
- the definition of materiality, including how the ISSB's definition of materiality aligns with the definition of materiality in financial reporting. Paragraphs 6–23 include an overview of the differences between single and double materiality; and the interoperability challenges for UK entities that may report under other jurisdictional sustainability reporting frameworks that use different definitions of materiality.
- the application of the materiality definition. Paragraphs 24–29 include a consideration of the practical challenges of applying the ISSB's materiality definition including determining the distinction between material information and the significance of risk.
- the effect of materiality on the location of disclosures. Paragraphs 30–31 addresses how the definition of materiality may interact with the location provisions in IFRS S1.
Definition of materiality
Aligning the definition of materiality with that used in IFRS Accounting Standards
6 IFRS S1 states that 'information is material if omitting, obscuring or misstating it could be reasonably expected to influence decisions that primary users of general purpose financial reports make on the basis of those reports.' Materiality is entity specific. IFRS S1 paragraph D8 notes that materiality is ‘an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information relates, in the context of the entity's sustainability-related financial disclosures.' Accordingly, and as noted in IOSCO's endorsement assessment of IFRS S1 and IFRS S2, 'notwithstanding the inclusion of cross-industry metrics and the reference to industry-based SASB standards and other sources of guidance, the entity's disclosures must ultimately be made on the basis of an entity-specific judgement.' As set out in IFRS S1 paragraph B15, the user decisions referred to 'depend on primary users' expectations about returns, for example, dividends, principal and interest payments or market price increases.' IFRS S1 defines primary users as 'existing and potential investors, lenders and other creditors.'
7 IFRS S1 Basis for Conclusions on General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1 Basis for Conclusions) paragraph BC68 notes the ISSB acknowledges that it has based the definition of materiality on the definition in the IFRS Conceptual Framework for Financial Reporting which sets out the fundamental concepts for financial reporting that guide the International Accounting Standards Board (IASB) in developing IFRS Accounting Standards. However, the definition in IFRS S1 is specific to sustainability-related financial disclosures and states that materiality judgements should be made in the context of an entity's sustainability-related financial disclosures. Additionally, IFRS S1 Basis for Conclusions notes that IFRS Sustainability Disclosure Standards are designed to be applied with any Generally Accepted Accounting Practice (GAAP), even though the definition of materiality is not the same in every GAAP.
8 UK companies must prepare their accounts in accordance with applicable accounting standards, either:
- the body of accounting standards published by the UK's Financial Reporting Council (FRC), including FRS 102, FRS 102 (which contains separate disclosure requirements for small entities in Section 1A Small Entities), FRS 105, and FRS 101; or
- 'UK-adopted international accounting standards', which companies with listed securities are required to apply in their consolidated financial statements. UK-adopted international accounting standards are IFRS Accounting Standards as issued by the IASB with some limited modifications.
It should be noted that should non-UK companies voluntarily disclose or be captured by requirements to report under UK Sustainability Reporting Standards, for example because they have UK-listed equity or debt, those non-UK companies may be likely to be reporting under GAAP from other jurisdictions.
9 Overall, UK stakeholders indicated support for the approach taken by the ISSB to align the definition of materiality to that used in financial reporting. It is anticipated that this approach will enhance connectivity between the financial statements and sustainability-related disclosures and may also improve the quality of corporate reporting within the UK in the long term.
10 However, there was recognition by stakeholders that there may be challenges in applying this materiality definition to all sustainability-related matters, especially those that are more complex. For example, determining the materiality of social matters such as human rights using the definition in IFRS S1 may be challenging. In this regard, some stakeholders mentioned the limitations of the definition of materiality in IFRS S1 and the benefits that would be brought by bringing a broader materiality lens that considers wider impacts and the unintended consequences of corporate actions.
11 As discussed in the TAC paper 2024-TAC-001 ‘Assessment approach’, this technical assessment is only on IFRS S1 as it currently stands and does not extend to any future IFRS Sustainability Disclosure Standards. If the ISSB issues new standards in the future, or amends IFRS S1, it is likely that the current TAC assessment of IFRS S1 will need to be revisited.
Distinction between material information and significance of risk
12 On terminology it is important to note that IFRS Sustainability Disclosure Standards refer to materiality in the context of material information about sustainability-related risks and opportunities—they do not use the term 'material risks and opportunities'. Furthermore, while materiality for the IASB has primarily been applied by the IASB for financial reporting, it is considered in the context of sustainability-related financial disclosures for the ISSB.
13 The UK Guidance on the Strategic Report defines materiality as 'Information is material if its omission or misrepresentation could reasonably be expected to influence the economic decisions shareholders take on the basis of the annual report as a whole.'
14 Although the wording is slightly different to the definition in IFRS S1, it is anticipated that in practice it will lead to the same outcome in terms of identifying and disclosing material sustainability-related risks and opportunities.
Single and double materiality
15 Aligning the definition of materiality for IFRS S1 with IFRS Accounting Standards may assist practitioners that are already familiar with applicable accounting and reporting requirements in the UK and the IFRS Foundation's materiality concept. It may also promote better connectivity and consistency across sustainability-related disclosures and financial statements for entities already reporting using IFRS Accounting Standards. However, stakeholders have flagged differing views as to whether, from both a philosophical and practical standpoint, it is appropriate to maintain the same materiality lens for sustainability-related information as that used for financial statements.
16 Whilst the focus on material information in IFRS S1 is on information about sustainability-related risks and opportunities that could reasonably affect the entity's prospects, other sustainability reporting frameworks take a broader view of material information. For example, Article 19a of the EU Corporate Sustainability Reporting Directive (CSRD) states that undertakings 'shall include in the management report information necessary to understand the undertaking's impacts on sustainability matters, and information necessary to understand how sustainability matters affect the undertaking's development, performance and position.' This concept is further elaborated on in Recital 29 of the CSRD:
Those Articles therefore require undertakings to report both on the impacts of the activities of the undertaking on people and the environment, and on how sustainability matters affect the undertaking. That is referred to as the double materiality perspective, in which the risks to the undertaking and the impacts of the undertaking each represent one materiality perspective. The fitness check on corporate reporting shows that those two perspectives are often not well understood or applied. It is therefore necessary to clarify that undertakings should consider each materiality perspective in its own right, and should disclose information that is material from both perspectives as well as information that is material from only one perspective.
17 The description of sustainability-related risks and opportunities in IFRS S1 paragraph 2 explicitly mentions an entity's impacts on resources and relationships, including society and the natural environment, as potential sources of sustainability-related risks and opportunities for the entity:
Information about sustainability-related risks and opportunities is useful to primary users because an entity's ability to generate cash flows over the short, medium and long term is inextricably linked to the interactions between the entity and its stakeholders, society, the economy and the natural environment throughout the entity's value chain. Together, the entity and the resources and relationships throughout its value chain form an interdependent system in which the entity operates. The entity's dependencies on those resources and relationships and its impacts on those resources and relationships give rise to sustainability-related risks and opportunities for the entity.
Therefore, entities might consider impacts when using the IFRS Sustainability Disclosure Standards, insofar as the impacts lead to sustainability-related risks and opportunities that could affect an entity's prospects and the information meets users' needs as set out in IFRS S1.
18 Some stakeholders consider that sustainability reporting should have a broader purpose than providing information to investors to make capital allocation decisions and are supportive of the EU's broader focus on the sustainability related impacts of companies on people and the environment. However, over time the impact of the entity's activities on the external environment could ultimately affect the entity's financial position, financial performance and cash flows—which is referred to as an entity's 'prospects' in IFRS S1. This concept is referred to as dynamic materiality. If, for example, the company causes a significant environmental incident which pollutes the environment, in due course this may flow into legal, punitory and rectification costs and affect the company's prospects. As such the impact on the external environment will then be financially material to the company. However, the financial impact on the entity may be delayed until the effects of the environmental incident come to light and are addressed. This delay, some primary users argue, may mean that they find out the information too late. Although reporting on double materiality will identify the impact on people and the environment in a more timely and comprehensive way, it may be argued that aspects of this concept will nonetheless filter through to the financial materiality lens eventually, and therefore one of the key differences between the two approaches is timeframes.
19 Certain UK companies with operations in the European Union (EU) will be required to report under the CSRD, including, in some circumstances, reporting at full consolidated group level. Other entities may voluntarily choose to report through the double materiality lens to meet both primary user and broader stakeholder needs. Although the financial lens in the European Sustainability Reporting Standards (ESRS) is the same as that in IFRS S1, feedback from UK stakeholders preparing to report under the CSRD has indicated that double materiality significantly increases the reporting burden. These stakeholders have advised that it is particularly challenging when looking at sustainability matters beyond climate change.
Interoperability
20 The appropriateness of whether the IFRS Sustainability Disclosure Standards should adopt a double materiality focus is outside the scope of the technical assessment by the TAC. As set out in the Framework document 'the TAC may also propose amendments to build upon the material provided within the global baseline provided by a IFRS Sustainability Disclosure Standard, upon request from DBT or where UK stakeholders raise a strong need.' UK stakeholders have not raised a strong need in this respect.
21 However, for entities that expect to be required to report under UK Sustainability Reporting Standards and the CSRD and/or other jurisdictional sustainability reporting frameworks that may use different definitions of materiality, there are likely to be very real challenges in providing differing sets of disclosures in a cohesive and connected way while minimising duplication.
22 In an ISSB update paper presented to the Global Preparers Forum (GPF) in March 2024, the ISSB highlighted its commitment to supporting interoperability with other jurisdictional and voluntary initiatives. This includes the development of guidance on how to use the IFRS Sustainability Disclosure Standards in a way that is connected to and interoperable with other standards. In May 2024, the IFRS Foundation and the European Financial Reporting Advisory Group (EFRAG) published interoperability guidance to illustrate the high level of alignment achieved between IFRS S2 Climate-related Disclosures (IFRS S2) and ESRS E1 Climate change (ESRS E1) and show how a company can apply both sets of standards. It should be noted that the definition of materiality for users of general purpose financial reports—often referred to financial materiality—is aligned between the two sets of standards. In May 2024, the IFRS Foundation and the Global Reporting Initiative (GRI) committed to jointly identify and align common disclosures that address information needs under the distinct scopes and purposes of their respective standards, for both thematic and sector-based standard-setting.
23 Given its mandate as set out in the Framework document to 'provide a focal point for UK stakeholders to influence the ISSB on technical matters throughout its standard-setting process', the TAC may wish to support the ISSB's work on interoperability to ensure it focuses on the key challenges for UK entities that may be required to report using UK Sustainability Reporting Standards and other jurisdictional sustainability reporting frameworks. This should enhance international comparability and may reduce the cost and effort required by UK entities that also need to report under sustainability reporting frameworks in other jurisdictions. The TAC may also wish to observe practice as it develops in order to better understand the practical challenges of applying two sets of materiality concepts.
The application of the materiality definition
24 As set out in IFRS S1 Basis for Conclusions paragraph BC69, materiality judgements for sustainability-related financial disclosures will inevitably differ from those for financial statements because:
- information about sustainability-related risks and opportunities is unconstrained by definitions of assets and liabilities and the criteria for recognising them;
- the ISSB expects that in preparing sustainability-related financial disclosures, entities will often have to consider financial implications over
- longer time periods than the time periods considered in preparing financial statements;
- in preparing sustainability-related financial disclosures, entities will need to consider the financial implications of interactions throughout their value chain; and
- the ISSB observed that sustainability-related financial information may have different measurement bases compared to information included in financial statements.
25 In addition to the points above, the overall quality of data used in sustainability-related reporting and the assessment of materiality is, for the most part, lower than data used for financial reporting. Different aspects of sustainability-related data may be more reliable than others and over time it is hoped that the quality of data will improve. However, the limitations and quality issues with sustainability-related reporting pose additional challenges to entities in assessing and determining materiality. This is because they will need to make materiality judgements based on less robust information about sustainability-related risks and opportunities.
26 In addition to the data quality issues, assessing materiality for certain sustainability-related matters such as biodiversity and social matters may need to rely more heavily on assumptions and estimates. Stakeholders have flagged that the level of judgement that will need to be applied is far greater than that currently applied in financial reporting. For example, two similar companies with a similar risk or opportunity may assess the matter in a significantly different way leading to different materiality assessments. Whilst materiality is entity-specific and could lead to different disclosures, there may be some common assumptions that entities could use in their assessment that improve comparability and support a common understanding of the sustainability-related risks and opportunities. Over time, it is hoped that practices will converge, but it is likely that there will be variation in the reporting of certain sustainability-related matters for several years.
27 As processes and data quality improve, it is also likely that the need to revise prior year reports will be higher than that typically seen for financial statements. This may be due to errors or because additional information on estimates or approximations comes to light. The need for restatement may arise from data generated by the entity itself or from data received from third parties in the value chain. This may affect materiality assessments. There may be a need for recognition that, particularly in the early years of adoption, there may be a more frequent need for restatements which may give rise to reassessments of materiality. Paper 2024-TAC-007 on judgements, uncertainties and errors, including revising comparatives was discussed at the June 2024 TAC meeting. As part of that discussion, TAC members noted the importance of using materiality judgements when determining when to restate or revise comparatives.
28 IFRS S1 paragraph 74 requires an entity to disclose information about the judgements the entity has used when preparing its sustainability-related disclosures. IFRS S1 paragraph 75(c) notes that this might include information about the judgements used when identifying material information. When identifying a sustainability-related risk or opportunity, IFRS S1 states that if there is not an IFRS Sustainability Disclosure Standard that specifically applies to a particular sustainability-related risk or opportunity, entities should look to the requirements on sources of guidance set out in IFRS S1 paragraphs 57–58. These sources of guidance may therefore influence the materiality consideration. TAC paper 2024-TAC-011 will address issues and considerations in relation to the sources of guidance.
29 Many UK stakeholders identified a need for additional guidance on materiality including worked examples to assist entities. In February 2024 a paper on Developing educational material on materiality was discussed at the ISSB meeting. The paper noted that ISSB staff are ‘developing targeted educational material to explain the application of the concept of materiality in the context of the requirements in IFRS Sustainability Disclosure Standards.' This educational material may meet the needs identified by stakeholders. The TAC Secretariat proposes to monitor this work and, through its engagement with UK stakeholders, identify if there is a need for any further educational material/guidance. If gaps are identified, the TAC Secretariat recommends that the TAC could look to engage directly with the ISSB on the development of further materials.
Materiality and the location of disclosures
30 The UK Guidance on the Strategic Report ‘recommends that information that is material to shareholders should be included in the strategic report.' The definition of materiality in this guidance also states that 'only information that is material in the context of the strategic report should be included within it.' IFRS S1 paragraph B27 states that 'an entity shall not obscure material information.' Whilst the provision in IFRS S1 is a requirement, the Guidance on the Strategic Report is non-binding guidance. To ensure that sustainability-related disclosures comply with UK Sustainability Reporting Standards they must not be obscured. Therefore, care will need to be taken with their presentation in the strategic report. IFRS S1 Basis for Conclusions (paragraph BC74) sets out ways in which entities may ensure that material information required by IFRS Sustainability Disclosure Standards is made prominent and distinguishable from immaterial information provided to satisfy law, regulation, or other requirements.
31 At its June meeting, the TAC discussed the location provisions for disclosures under IFRS S1 and noted the important link to materiality. For example, TAC members suggested that perhaps consideration could be given to prescribing a minimum set of mandatory disclosures that would belong in the strategic report. Material disclosures could be included in the strategic report and other non-material sustainability-related disclosures could be located elsewhere. This is an implementation issue, but to maintain the flexibility of location provision in IFRS S1, consideration should be given to how this requirement would interact with existing provisions and guidance covering the annual report and accounts.
Endorsement recommendations
Alternative options considered but not recommended
32 In considering the TAC's endorsement recommendations on the materiality provisions set out in IFRS S1, the Secretariat considered alternative options that have been disregarded. The criteria for amending the standards—notably that changes are considered necessary for the effective application within the UK and failure to amend the standard would be of detriment to the long-term public good—have not been met in this instance.
33 The alternative options that were considered but not recommended include to:
- consider a broader definition of materiality beyond single materiality. Some UK stakeholders have questioned the appropriateness of maintaining the same materiality lens for sustainability-related information as that used for financial statements. However, changing the single materiality focus of IFRS S1 would diverge both from the current UK legal reporting framework which is investor-focused, and from the global baseline that the standards are seeking to establish and could compromise the international comparability of disclosures. It should also be noted that the way in which IFRS S1 and IFRS S2 have been designed is based on the single materiality lens; if these standards were intended to contemplate a double materiality lens, then they would almost certainly be drafted differently.
- consider the development of UK guidance on materiality for the application of the UK Sustainability Disclosure Standards. This option was not considered appropriate at this stage as it could compromise the international comparability of UK entities' reporting and could lead to divergence from the global baseline. In addition, this is not a UK-specific issue. Any necessary guidance on the application of materiality should be produced by the ISSB. As noted earlier in this paper, the ESRS financial materiality lens is aligned with the ISSB's financial materiality lens so the two are not incompatible.
Suggested endorsement recommendation
34 On balance, and based on the analysis provided in this paper, the TAC is asked to tentatively recommend to maintain the materiality definitions in IFRS S1 without amendment. Aligning the definition of materiality for IFRS S1 with IFRS Accounting Standards may assist practitioners that are already familiar with applicable UK accounting and reporting standards and the IFRS Foundation's materiality concept. Overall, UK stakeholders indicated support for the approach taken by the ISSB to align the definition of materiality to that used in financial reporting.
35 Additionally, the TAC may decide that in its role of providing a focal point for UK stakeholders to influence the ISSB on technical matters throughout its standard-setting process, the TAC and Secretariat will:
- monitor the development of educational material by the ISSB on materiality and, if a need for any further educational material/guidance is identified, engage with the ISSB to encourage the development of this additional material; and
- support the ISSB's work on interoperability to ensure it focuses on the key challenges for UK entities that will report under both UK Sustainability Reporting Standards and other jurisdictional sustainability reporting frameworks which may use a different definition of materiality.
Questions for the TAC
- Does the TAC agree with the analysis in this paper in relation to the materiality provisions in IFRS S1?
- Does the TAC tentatively recommend to maintain the materiality provisions in IFRS S1 without amendment?
- Does the TAC agree with the proposed ways forward as set out in paragraph 35 and that these items should be noted in the TAC's advice to DBT?
This paper has been prepared by the Secretariat for the UK Sustainability Disclosure Technical Advisory Committee (TAC) to discuss in a public meeting. This paper does not represent the views of the TAC or any individual TAC member.
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