In our previous article, we looked at the definitions of materiality under IFRS SDS. Generally speaking, the starting point for identifying material information for financial reporting purposes is the ‘what could go wrong’ enterprise risk management approach.

Unlike the process of identifying material topics, which may require complementing management’s perspective by engaging with external stakeholders (as part of a materiality assessment), materiality of information is a judgement that is made by management, but through the lens of an external user of its financial statements. 

In practice, organisations will apply their materiality lens judgments (such as 1% of revenue, or 5% of profit, and so on) when reporting externally on material financial information. Keep in mind that subsidiary versus group thresholds will also differ and those quantitative thresholds of materiality are not necessarily the same as the ones applied by the organisation’s audit team(s).

What’s different when preparing sustainability reporting

Financial materiality is often linked to time horizon, but financial reporting is based on actual events within a specific reporting period. When considering sustainability topics, the time horizon must extend beyond that for financial materiality. Sustainability is inherently a long-term concept and is more forward-looking in nature. 

The conundrum for accounting professionals is: how do they reflect potential future events in financial statements? Well, they can’t. So sustainability information that is material to external users, but that does not qualify for inclusion in financial statements will find itself in the management discussion and analysis (MD&A) or sustainability statements. 

In other words, accounting professionals need to include sustainability related topics within their ‘what could go wrong’ enterprise risk management approach. When assessing materiality, the thresholds may need to be more qualitative than quantitative.

More broadly, accounting professionals must get comfortable with applying their natural skill set to an expanded scope of impacts, risks and opportunities, knowing that information material to users of general purpose financial reports can be captured not only in the MD&A or financial statements, but also in sustainability statements. 

For example, a construction company supplying building materials carries forests it owns for lumber on its balance sheet as assets. Its initial accounting of the value of these assets using a financial materiality lens would be to consider them for lumber (as an inventory asset) and for potential impairment if the value of the assets for resale was below the accounting value on the books. However, an expanded sustainability materiality lens would also naturally lead the company to consider potential risks to the value of these assets, such as extreme weather events and exposure to droughts, as well as the environmental positive (or negative) impacts of preserving (or destroying) the forests on biodiversity, air quality, soil erosion, leisure use and community health.

What doesn’t change

Accounting professionals are well – and some would say uniquely – suited to evolving their organisation’s general purpose financial reports to include a broader set of information material to users because when opening the aperture of the materiality lens to include the sustainability perspective they must also follow long-standing rules of professional conduct:

• Professional duty of care (also known as do-no-harm) – this is a universal foundation of financial reporting that has been around for decades.
• Acting in the public interest – accounting professionals have a duty to act in the public interest and to consider potential effects of reputational loss or shareholder action, even in the absence of laws and regulations.
• Ethics – accounting professionals are guided by strong ethics and ethical behaviour to act in the public interest and ensure their organisation’s long-term viability. Increasingly, this means integrating the broader lens of sustainability materiality when carrying out their professional responsibilities. In fact, the International Ethics Standards Board for Accountants’ recently certified Global Ethics Sustainability Standards, which encompass the International Ethics Standards for Sustainability Assurance (including International Independence Standards for assurance purposes), revisions to existing sustainability reporting standards and a new standard on using the work of external experts.

Beyond disclosures, management

By embracing the connectivity between sustainability and finance and understanding both the financial and sustainability perspectives to material information, accounting professionals are well positioned to navigate their organisation’s expanded disclosure obligations. Their unique qualifications – their duty of care to protect the public interest and their professional ethics – also serve them well to better anticipate a broader set of impacts, risks, and opportunities relevant to their organisation and to more effectively manage them, avoiding costly surprises and ensuring they build a resilient going concern.