The Materiality of Accounting Errors: Evidence From SEC Comment Letters
Posted: 2 Aug 2018
Date Written: June 1, 2018
We gain unique insights into materiality judgments about accounting errors by examining SEC comment letter correspondence. We document that managers typically use multiple quantitative benchmarks in their materiality analyses, with earnings being the most common benchmark. In most of the cases we review, managers deem the error immaterial despite exceeding the traditional “5 percent of earnings” rule of thumb, often in multiple periods and by a large degree. Instead of attempting to conceal these overages, managers tend to forthrightly acknowledge them, often asserting that the benchmark is abnormally low during the violation period. We find that 17 to 26 percent of these “low benchmark” assertions are suspect (although none of these “low benchmark” assertions are challenged by the SEC). We also document substantial variation in the extent to which qualitative factors are mentioned as considerations. The SEC generally is deferential toward managers’ arguments and judgments, but is more likely to challenge immateriality claims when managers admit there are qualitative factors that indicate errors are material.
Keywords: Materiality, Errors, Restatements, Sec Comment Letters
JEL Classification: M40
Suggested Citation: Suggested Citation