Determining Materiality

Key Challenge

Understanding and reconciling approaches to applying materiality to sustainability reporting.

Background

The materiality concept is well established in financial reporting, although its application is not always without controversy. The principle of materiality guides the audit process. Materiality is also an important filter for organizations to use in their sustainability reporting. It helps organizations to decide on the relevant issues to disclose for the benefit of stakeholders. User perception of materiality can differ between users, preparers, and auditors because of their differing incentives. However, there is adequate guidance on the application of materiality to a wider stakeholder perspective to support sustainability reporting.

The adoption of the materiality principle into reporting is covered by various definitions, each of which is reconcilable, given the specific assumptions and considerations outlined below (under key considerations). The main definitions are:

Global Reporting Initiative Sustainability Reporting Guidelines:

The information in a report should cover topics and Indicators that reflect the organization's significant economic, environmental, and social impacts, or that would substantively influence the assessments and decisions of stakeholders.

In its explanatory material, GRI states: Organizations are faced with a wide range of topics on which it could report. Relevant topics and Indicators are those that may reasonably be considered important for reflecting the organization's economic, environmental, and social impacts, or influencing the decisions of stakeholders, and, therefore, potentially merit inclusion in the report. Materiality is the threshold at which an issue or Indicator becomes sufficiently important that it should be reported.

The IASB's 2005 discussion paper on Management Commentary defines materiality as:

Information in financial reports should include topics, issues and performance measures (indicators) that reflect an organization's significant economic, environmental, and social impacts. An organization could report on many issues. Relevant topics, issues and measures should relate to an organization's economic, environmental, and social impacts. Materiality is the threshold at which an issue or measure becomes sufficiently important to report. Beyond this threshold, not all material issues will be of equal importance and reporting should reflect the relative importance of material issues.

AccountAbility's Guidance note on the principles of materiality, completeness and responsiveness as they relate to the AA1000 Assurance Standard:

Requires that the Assurance provider states whether the Reporting Organization has included in the report the information about its sustainability performance required by its stakeholders for them to be able to make informed judgements, decisions and actions. The guidance goes on to discuss the determination of materiality, a process for evaluating adherence to the principle.

The common theme of materiality definitions for sustainability reporting is that materiality is relevant to a wider range of impacts and stakeholders. Furthermore, materiality for sustainability reporting is not limited only to those sustainability topics that have a significant financial impact on the organization. Some organizations are also transparent over their materiality criteria - see caption 42.

Key Considerations

In defining report content, materiality should be considered along with the need for other important information characteristics: These characteristics include completeness, accuracy, comparability, timeliness, clarity, and reliability. Sometimes trade-offs exist between characteristics, and sometimes they are closely associated. For example, reliability and materiality are connected because the reliability of information and processes used to prepare a report helps to establish the quality and materiality of the information.

Accountability for materiality thresholds: Materiality thresholds may be agreed upon between management and an assurance provider. However, management, rather than the assurance provider, should determine the materiality tests and thresholds, although agreement may be subsequently reached with the assurance provider on the threshold and definition used. An organization's governance arrangements can (a) explicitly state where the responsibility for materiality decisions lies, and (b) recognize that although stakeholders will participate in and influence the determination of materiality, it is the organization's management that has responsibility and accountability for the final decision.

Materiality varies within organizations: Material issues will vary between different segments of an organization. For example, carbon dioxide emissions may only be material and relevant for one division of an extractive industry. Other divisions may have such minimal carbon footprints that they are not required to report on these issues.

Linking the determination of materiality to strategy and risk management: Decisions on materiality are made and supported by discussions and decisions made on (a) key organizational values, policies, strategies, targets, and goals, (b) the interests and expectations of stakeholders uncovered in stakeholder relations, and (c) identification of significant risks and opportunities (see Business Strategy perspective). Determination of materiality should not be divorced from these activities. An organization's eco-efficiency measurements and related internal performance indicators will also provide an important basis for measurements included in sustainability reports.

Determining a process for resolving dilemmas between different expectations regarding materiality: Agreement on materiality is not always straightforward, as stakeholders can have a different perspective and set of concerns that are not easily reconcilable with the organization's mission and objectives. One way of dealing with differences on materiality expectations is to disclose information used by external stakeholders that differs from the information used internally for day-to-day management purposes. Such information can support (a) assessments or decision-making by stakeholders, or (b) engagement with stakeholders that can result in actions that would significantly influence performance, or address key topics of stakeholder concern.