The Effect of Quantitative Materiality Approach on Auditors' Adjustment Decisions

Posted: 25 Feb 2005

See all articles by Mark W. Nelson

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management

Steven D. Smith

Brigham Young University

Zoe-Vonna Palmrose

University of Southern California

Abstract

Two alternative approaches are used in audit practice to provide 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. Depending on the relation between total misstatement and current-period misstatement, either the cumulative approach or the current-period approach can calculate higher quantitative materiality. This paper reports an experiment that varies materiality approach between auditors by providing auditors with either the current-period or cumulative formats used by their firm to summarize proposed audit adjustments. Results indicate that, across a variety of experimental contexts (varying misstatement size, subjectivity, precision and income effect, and varying whether auditors document effects on their client's quality of earnings), auditors are more likely to require their client to book the misstatement under the approach that makes the misstatement appear more material. These results suggest that standard setters mandate that auditors require adjustment whenever a misstatement is material under either approach.

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

JEL Classification: M41, M43, M49

Suggested Citation

Nelson, Mark W. and Smith, Steven D. and Palmrose, Zoe-Vonna, The Effect of Quantitative Materiality Approach on Auditors' Adjustment Decisions. Accounting Review, July 2005. Available at SSRN: https://ssrn.com/abstract=671662

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)

Steven D. Smith

Brigham Young University ( email )

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

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)

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