SASB Chapter 2 Vocab Flashcards
Materiality
The concept of “materiality” traditionally focuses on information that impacts financial performance and investor decision making. In the wake of regulatory efforts to enhance transparency from corporations, the concept was adopted to provide guidance to reporting companies. Though companies were now held to higher standards of transparency, to require the disclosure of all information would place undue burden on reporting companies. “Materiality” dictates what companies are (and are not) obligated to disclose.
TSC v. National (2004)
When confronted with a situation in which two companies, National and TSC, filed a joint proxy statement to gain shareholder approval for National to acquire TSC, a shareholder alleged that the proxy statement failed to include the material fact that executives at National also served on TSC’s board. The case centered around the key question: Would knowledge of National executives serving on TSC’s board have changed reasonable investors voting decisions. The US Supreme Court determined that information is material if its exclusion would have altered the the “total-mix” of information considered to be reasonable to and investor
“Total-Mix”
Determined in TSC vs. National. The total mix concept suggests that material information is not defined by whether or not it would have changed an investors decision. Rather, information is deemed to be material if it is significantly likely to be considered by a reasonable investor in investment decisions - a higher threshold than if it “might” be considered - by such an investor.
Basic Inc vs. Levinson (1988)
Two companies, Basic Inc. and Combustion Engineering Inc., announced a merger after making three public statements that merger negotiations were not taking place. The case investigated whether the public denial of merger conversations was materiality false or misleading to shareholders. The court found the public statements to be misleading based on both the standard for materiality established in TSC v. Northway and by assessing materiality using a probability and magnitude test. According to this test, the determination of materiality should also consider the probability that an event will happen and the magnitude of the occurrence of the event. Ex. A relatively small transaction for the company, or one that involves a small price premium, will not likely meet the probability and magnitude test for materiality. Ex Sustainability. BP Pipeline.
Probability-and-Magnitude
In subsequent cases the US Supreme Court expanded on the definition of “materiality” by indicating that materiality can be assessed by the probability that an event may take place and the magnitude of impact of the event on the company. Determined in Basic Inc. vs Levinson (1988) by using the precedent set on materiality by TSC vs. Northway, and a new probability and magnitude test; According to this test, the determination of materiality should also consider the probability that an event will happen and the magnitude of the occurrence of the event.
GAAP
Generally Accepted Accounting Principles (GAAP): The establishment of GAAP aimed at improving the consistency and comparability of financial reporting procedures. GAAP helps maintain trust in the financial markets. Without GAAP investors would be more reluctant to trust the information presented to them by companies because they would have less confidence in its integrity. GAAP is a set of procedures and guidelines used by companies to prepare their financial statements and other accounting disclosures. The standards are prepared by the Financial Accounting Standards Board (FASB). The purpose of GAAP standards is to help ensure that the financial information provided to investors and regulators is accurate, reliable, and consistent with one another. Pro forma accounting is non-GAAP accounting. The ultimate goal of GAAP is to ensure a company’s financial statements are complete, consistent, and comparable. Most other jurisdictions use IFRS standards.
10 GAAP Principles
- Principle of Regularity: The accountant has adhered to GAAP rules and regulations as a standard.
- Principle of Consistency: Accountants commit to applying the same standards throughout the reporting process, from one period to the next, to ensure financial comparability between periods. Accountants are expected to fully disclose and explain the reasons behind any changed or updated standards in the footnotes to the financial statements.
- Principle of Sincerity: The accountant strives to provide an accurate and impartial depiction of a company’s financial situation.
- Principle of Permanence of Methods: The procedures used in financial reporting should be consistent, allowing a comparison of the company’s financial information.
- Principle of Non-compensation: Both negatives and positives should be reported with full transparency and without the expectation of debt compensation.
- Principle of Prudence: This refers to emphasizing fact-based financial data representation that is not clouded by speculation.
- Principle of Continuity: While valuing assets, it should be assumed the business will continue to operate.
- Principle of Periodicity: Entries should be distributed across the appropriate periods of time. For example, revenue should be reported in its relevant accounting period.
- Principles of Materiality: Accountants must strive to fully disclose all financial data and accounting information in financial reports.
- Principle of Utmost Good Faith: Derived from the Latin phrase Uberrimae fidei used within the insurance industry. It presupposes that parties remain honest in all transactions.
Historical Cost Accounting
In the 1930s, best practices for preparing financial statements relied on historical cost accounting, which measures an assets value as the actual cost paid for the asset at the time of purchase. Under this accuracy-focused approach, the original nominal value is reported on the balance sheet even if the value of the asset changes over time.
Investopedia: Historical cost accounting is a measure of value used in accounting in which the value of an asset on the balance sheet is recorded at its original cost when acquired by the company.
Externalities
Environmental externalities, such as pollution, illustrate that some corporate activities impose cost on the rest of society. Externalities refers to situations when the effect of production or consumption of goods and services imposes costs or benefits on others which are not reflected in the prices charged for the goods and services being provided.
