Auditors’ Quantitative Materiality Judgments: Properties and Implications for Financial Reporting Reliability

65 Pages Posted: 26 Apr 2017 Last revised: 30 Jun 2019

See all articles by Preeti Choudhary

Preeti Choudhary

University of Arizona, Eller College of Management

Kenneth J. Merkley

Indiana University - Kelley School of Business - Department of Accounting

Katherine Schipper

Duke University - Fuqua School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: June 28, 2019

Abstract

We analyze data made available through the PCAOB (Public Company Accounting Oversight Board) to provide descriptive evidence on the properties of auditors’ actual quantitative materiality judgments and the implications of those judgments for financial reporting. Auditors’ quantitative materiality judgments do not appear to result simply from applying conventional rules-of-thumb, (e.g., 5% of pre-tax income), but instead are associated with size-related financial statement outcomes (income, revenues and assets), where the relative importance of the size-related outcomes varies with client characteristics such as financial performance. Using the distribution of actual materiality amounts reported by auditors to the PCAOB as part of the audit-inspection process, we construct a materiality-judgment measure that locates a specific materiality amount within a normal range that is both comparable across varying client characteristics and supported by guidance in audit firm internal policy manuals. We find that looser materiality (an amount closer to the high end of a normal materiality range) is associated with fewer audit hours and lower audit fees, supporting the construct validity of this measure. We also find that looser materiality is associated with lower amounts of proposed audit adjustments and, in extreme cases, with a greater incidence of restatements, highlighting the importance of auditor materiality assessments for financial reporting reliability.

Keywords: Financial Reporting, Materiality, Auditing, Reporting Quality

JEL Classification: M41, M42, M48, C80

Suggested Citation

Choudhary, Preeti and Merkley, Kenneth J. and Schipper, Katherine, Auditors’ Quantitative Materiality Judgments: Properties and Implications for Financial Reporting Reliability (June 28, 2019). 28th Annual Conference on Financial Economics and Accounting, Available at SSRN: https://ssrn.com/abstract=2958405 or http://dx.doi.org/10.2139/ssrn.2958405

Preeti Choudhary (Contact Author)

University of Arizona, Eller College of Management ( email )

School of Accountancy
Tucson, AZ 85721
United States

Kenneth J. Merkley

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Katherine Schipper

Duke University - Fuqua School of Business

Box 90120
Durham, NC 27708-0120
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
1,015
Abstract Views
4,020
rank
23,866
PlumX Metrics