By Alison Scott | 7 April 2014
We need more clarity and brevity in financial statements if they are to meet the needs of users. But too often public bodies play safe and fail to consider the 'materiality' of the information included
The public sector is well advanced in producing high-quality, audited, accrual-based financial statements. However, an important question remains – is the information they contain being used as intended by the standard setters, to inform decision making and accountability?
In local government, the need to produce financial statements that address both accounting and legislative frameworks leads to complexity. Some items have to be accounted for in ways that do not reflect how the authority manages its budget. Timing differences in recognising expenditure and a service analysis that reflects national accounts requirements rather than how an authority is organised are just two examples of this. Decision makers often struggle to understand their own financial statements, and the valuable information they contain can be overlooked when policies and strategies are being considered.
Both CIPFA/LASAAC and the Treasury are aware of these problems and are reviewing how to simplify financial accounts across the public sector, but any changes will take time. However, there is much that individual organisations can do to improve their financial statements.
CIPFA published Financial statements: a good practice guide for local authorities in late 2013. This looks at how the presentation can be improved and clutter cut from the accounts.
Too often, organisations play safe by including every disclosure required by standards, in case an omission is questioned. And too often, auditors question the omission of non-material disclosures, encouraging this behaviour.
If financial statements are to reduce in size, everyone involved needs to take materiality seriously. So how can materiality to the reader of the accounts be used to drive improvements in clarity and brevity?
In considering materiality, a number of key factors can be found in the definition.
l First, an item is not material if omitting or misstating it would not influence the decisions that users might make. As the Accounting Code notes, materiality is an aspect of relevance so omitting credit risk information that showed an authority had a significant proportion of its investments in high-risk institutions could influence the decision of a lender on whether to lend, or at what rate. Conversely, omitting credit risk information where a debt-free authority had all its investments in government-backed investments is less likely to be material, at least from a lender’s perspective.
l Second, materiality does not just depend on the magnitude of an item; its nature is also relevant. A small investment in a high-risk institution might not be material when compared with the total value of investments; but it might be material by nature if the authority had already suffered a default by that institution, as users may question the authority’s investment strategy, and make different decisions.
l Third, the individual context needs to be considered. An item may not be material by magnitude, and its nature may be unremarkable, but if it is the difference between an authority showing a surplus or a deficit on its General Fund for the year, then it may be. Users may assess stewardship based on whether the authority’s net expenditure was within budget; so small items that resulted in the authority overspending its budget might be material for those users.
Finally, the information that should be disclosed needs to be considered. Even if an item is material, additional information about it may not be. We should not only ask ‘Is this item material?’ but also ‘Is this piece of information material?’ The second question may produce a different answer to the first. An item may be material, but the full accompanying information may not. Or information may not relate to a particular item, but be material.
At CIPFA, we are looking at the scope to be more radical in presenting accounts to better meet the needs of primary users. By focusing on materiality, public sector organisations can remove a great deal of clutter from their accounts relatively quickly. While some decisions can only be made in the context of final draft accounts, most of the work on cutting clutter can be done in advance. This should also facilitate the senior level input required. But, the bottom line is, there already is scope to make your 2013/14 accounts shorter and better focused if you want to take up that challenge now.
Alison Scott is assistant director, policy and technical, at CIPFA
This feature was first published in the April edition of Public Finance magazine
