Auditor Materiality Thresholds and Audit Quality – Evidence From The Revised ISA 700 in the U.K.

Abstract

Using a broad sample of U.K. firms that are required to disclose auditor materiality thresholds under the International Standards on Auditing (U.K. and Ireland) 700, we examine whether the auditor materiality threshold is associated with audit quality. We document that a lower materiality threshold is associated with higher audit quality, as measured by lower absolute discretionary accruals, higher accruals quality, and a lower propensity to just meet or beat analysts’ earnings expectations. We also find some evidence that the negative association between the materiality threshold and audit quality is attenuated when the audit committee is more effective and when the auditor is more economically dependent on the client, and the negative association is more pronounced when management has a stronger incentive to manage earnings. Overall, our study extends the limited studies on large-sample archival evidence on the implications of audit materiality thresholds on audit outcomes.

Keywords: Materiality threshold, audit report, audit quality

JEL Classification: M41, M42, M48