Materiality for a Significant Location 1020

  • We are a division of a foreign filer which is considered a significant location and thus will be ‘in scope’ for SOX testing.
    Is materiality going to be calculated at our location level or the filer level? The filer is MUCH bigger than we are making the difference between the two considerable.
    Any feedback in this area would be greatly appreciated.

  • Significant subsidiary %0AThe term ‘significant subsidiary’ means a subsidiary, including its subsidiaries, which meets any of the following conditions: %0A(1) The registrant’s and its other subsidiaries’ investments in and advances to the subsidiary exceed 10 percent of the total assets of the registrant and its subsidiaries consolidated as of the end of the most recently completed fiscal year (for a proposed business combination to be accounted for as a pooling of interests, this condition is also met when the number of common shares exchanged by the registrant exceeds 10 percent of its total common shares outstanding at the date the combination is initiated); or %0A(2) The registrant’s and its other subsidiaries’ proportionate share of the total assets (after intercompany eliminations) of the subsidiary exceeds 10 percent of the total assets of the registrant and its subsidiaries consolidated as of the end of the most recently completed fiscal year; or %0A(3) The registrant’s and its other subsidiaries’ equity in the income from continuing operations before income taxes, extraordinary items and cumulative effect of a change in accounting principle of the subsidiary exceeds 10 percent of such income of the registrant and its subsidiaries consolidated for the most recently completed fiscal year. %0A( Some years ago %0AMateriality had to do with the fact that an investor would not change his investment decisions by a fluctuation in net income less than or equal to 5%. This 5% rule was the fundamental basis for working materiality estimates.%0A 1999 - The rules of the game start changing %0ASEC Staff Accounting Bulletin No. 99, August 12, 1999 (which superseded SAS 82) spoke about materiality. %0A issues%0A’Misstatements are not immaterial simply because they fall beneath a numerical threshold’%0AThe SEC expressly rejected any quantitative test for materiality, including rules of thumb such as 5% of revenue or assets as even relatively small numerical differences could influence investors significantly, a fact possibly reflected in large increases or decreases in trading price.%0ABut, also:%0ADuring the course of preparing or auditing year-end financial statements, financial management or the registrant’s independent auditor becomes aware of misstatements in a registrant’s financial statements. When combined, the misstatements result in a 4% overstatement of net income and a USD.02 (4%) overstatement of earnings per share. Because no item in the registrant’s consolidated financial statements is misstated by more than 5%, management and the independent auditor conclude that the deviation from generally accepted accounting principles (‘GAAP’) is immaterial and that the accounting is permissible %0ASupreme Court has noted qualitative issues that may cause misstatements of quantitatively small amounts to be material, including:%0ADoes the misstatement mask a change in earnings or other trends?%0ADoes the misstatement hide a failure to meet expectations? %0ADoes the misstatement change a loss into income or vice versa?%0ADoes the misstatement satisfy requirements for the award of bonuses or other forms of incentive compensation to management?%0A After Sarbanes Oxley %0A External auditors may conclude that there is a material weakness even when the deficiency falls far below the 5 percent pretax income rule. %0AThe SEC has adopted implementing rules as mandated by the Act requiring the principal executive and financial officers of public companies to certify in each annual report on Form 10-K, 20-F or 40-F, and each%0Aquarterly report on Form 10-Q, and amendments to them, filed after August 29, 2002, that:%0A’Based on such officers’ knowledge, the report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading with respect to the period covered by the report’%0A Sarbanes-Oxley and its new implementing regulations are altering the interpretation of materiality.The SEC has explicitly warned companies that there is no quantitative threshold for materiality, stating that the test is whether the information would alter a reasonable investor’s view of the company. %0AAlso, Fraud, whether or not material, that involves management or other employees who have a significant role in the issuer’s internal control over finanacial reporting, must be disclosed%0AIn fact, SEC Staff Accounting Bulletin No. 99 continues to be the basis for interpretation in several circumstances. For example:%0AOn June 2, 2005 , SEC filed a civil action in federal district court against Huntington Bancshares Incorporated (a Maryland corporation and bank holding company headquartered in Columbus , Ohio). %0AThe SEC’s enforcement action focused on accounting misstatements that improperly inflated Huntington ‘s annual earnings per share (‘EPS’). SEC emphasized that the misstatements were nonetheless material under the qualitative factors described in SEC Staff Accounting Bulletin No. 99 (‘SAB 99’). %0ASEC vs. Huntington - demonstrates the significant weight the SEC gives to SAB 99’s qualitative materiality factors, particularly when earnings are manipulated in small increments to meet analysts’ expectations or to hit internal targets that trigger the payment of management bonuses.%0A consented to pay a civil penalty of USD7.5 million subject to court approval

  • I am assuming that you are interested in whether a particular test failure is going to be a SOX issue. I have commented on your question using this assumption.
    Since you have been deemed to be a significant location, your documentation of controls and tests of controls over your significant accounts must be performed and reviewed by your external auditors.
    Which accounts are significant was likely determined for you by your parent company based on business risks and account values.
    For SOX purposes, materiality is applied in determining how great the risk is that a control test failure could result in a misstatement of the financial statements. Materiality is evaluated for the total entity by aggregating the value of test failures for all locations tested .
    Therefore, your test failures must be reported regardless of the size of the estimated error so that they can be consolidated with other locations’ results.

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