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Quantitative Materiality Perspectives and Auditors' Disposition of Detected Misstatements

44 Pages Posted: 8 Mar 2004  

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management

Zoe-Vonna Palmrose

University of Southern California

Steven D. Smith

Brigham Young University

Date Written: January 30, 2004

Abstract

Two alternative approaches are used in audit practice to make quantitative materiality assessments about proposed audit adjustments: the cumulative approach compares to net income the total amount of misstatement existing at the end of the current period, while the current-period approach compares to net income the amount of misstatement added in the current period. The Panel on Audit Effectiveness and the SEC have expressed concern that these alternative materiality approaches could affect auditor judgments, but no research has investigated this question. We report the results of an experiment in which 234 audit managers and partners from one Big 4 firm completed eight cases that required them to determine whether the final outcome of an audit would be to book or waive a proposed adjusting journal entry. We manipulated materiality approach between auditors by providing auditors with either the current-period or cumulative formats used at their firm, and also manipulated whether auditors were provided with a prompt to consider their clients' quality of earnings. Results indicate waived adjustments for all cases, and a robust and often unintentional effect of materiality approach on auditors' adjustment decisions, but no effect of the quality of earnings prompt. Results also indicate that auditors' adjustment decisions are affected by misstatement size, subjectivity, current-period income effect, and precision.

Keywords: Materiality, auditing, adjusting entries, iron curtain, rollover, earnings management.

JEL Classification: M41, M44, M49, G14

Suggested Citation

Nelson, Mark W. and Palmrose, Zoe-Vonna and Smith, Steven D., Quantitative Materiality Perspectives and Auditors' Disposition of Detected Misstatements (January 30, 2004). Available at SSRN: https://ssrn.com/abstract=503662 or http://dx.doi.org/10.2139/ssrn.503662

Mark W. Nelson (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

448 Sage Hall
Ithaca, NY 14853
United States
607-255-6323 (Phone)
607-254-4590 (Fax)

Zoe-Vonna Palmrose

University of Southern California ( email )

Marshall School of Business, 0441
Los Angeles, CA 90089-0441
United States
213-740-5019 (Phone)
213-747-2815 (Fax)

Steven D. Smith

Brigham Young University ( email )

531 TNRB
Provo, UT 84602
United States
801-422-1969 (Phone)

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