Materiality Decisions and the Correction of Accounting Errors

Abstract:     
We test conjectures about the determinants of materiality judgments by examining a financial reporting choice made by firms that depends on an underlying materiality assessment. Specifically, from late 2004 to mid 2006, over 250 firms were required to correct errors in their accounting for operating leases. The method chosen to correct the errors reflects the assessed materiality of the errors, as restatements are required to correct material errors while catch-up adjustments can be used to correct immaterial errors. We test the role of materiality considerations outlined in authoritative guidance as well as factors outside the guidance in explaining the correction method chosen. We find that quantitative and qualitative materiality considerations cited in authoritative guidance explain a large portion of the variation in firms' error correction decisions. We also find that firms base their decisions on those of other firms.

Keywords: Materiality, accounting errors, restatements, leases

JEL Classification: M41, M43, M44

Accepted Paper Series