Abstract

http://ssrn.com/abstract=386562
 
 

References (20)



 
 

Citations (3)



 


 



Materiality Uncertainty and Earnings Misstatement


Evelyn Patterson


Indiana University - Kelley School of Business - Department of Accounting

Reed Smith


Indiana University - Kelley School of Business - Department of Accounting

March 2003


Abstract:     
The concept of materiality provides a basis for auditors to ignore small misstatements, but the definition of small in this context is ambiguous. The issue of "materiality-standard-setting" has been raised recently by Arthur Levitt, former chairman of the Security and Exchange Commission. We examine how materiality uncertainty affects the auditor's evaluation of audit evidence and a manager's choice of earnings overstatement in a strategic auditing model where earnings misstatements also include unintentional system error. We find that when the expected cost of accepting financial statements that are materially misstated, which we refer to as an audit failure, is relatively large, an increase in materiality uncertainty results in a more conservative auditor evaluation of the audit evidence and a decrease in the amount of intentional overstatement. Alternatively, if the auditor's expected cost of extending audit procedures is relatively high, then an increase in materiality uncertainty results in a less conservative auditor evaluation of the audit evidence and an increase in the manager's earnings overstatement. The auditor also becomes increasingly conservative as the report increases when the information system is sufficiently noisy. Finally, when the expected cost of audit failure is large, the equilibrium audit risk can increase or decrease in materiality uncertainty despite the corresponding increase in auditor conservatism and decrease in intentional overstatement. Audit risk is the average probability of audit failure across all possible evidence outcomes.

Number of Pages in PDF File: 46

Keywords: strategic audit, materiality, intentional overstatement, system of internal control

JEL Classification: M49, C72, G34

working papers series


Download This Paper

Date posted: May 23, 2003  

Suggested Citation

Patterson, Evelyn and Smith, Reed, Materiality Uncertainty and Earnings Misstatement (March 2003). Available at SSRN: http://ssrn.com/abstract=386562 or http://dx.doi.org/10.2139/ssrn.386562

Contact Information

Evelyn Patterson (Contact Author)
Indiana University - Kelley School of Business - Department of Accounting ( email )
1309 E. 10th Street
Bloomington, IN 47405
United States
317-278-7843 (Phone)

J. Reed Smith
Indiana University - Kelley School of Business - Department of Accounting ( email )
1309 E. 10th Street
Bloomington, IN 47405
United States
317-274-0867 (Phone)
317-274-3312 (Fax)

Feedback to SSRN


Paper statistics
Abstract Views: 3,070
Downloads: 611
Download Rank: 23,339
References:  20
Citations:  3

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo3 in 0.328 seconds