A Review and Integration of Empirical Research On Materiality: Two Decades Later

AUDITING: A JOURNAL OF PRACTICE & THEORY
Vol. 24, No. 2

November 2005
pp. 153187
A Review and Integration of

Empirical Research on Materiality:
Two Decades Later
William F. Messier, Jr., Nonna Martinov-Bennie,
and Aasmund Eilifsen
SUMMARY: There has been a renewed interest in the concept of materiality motivated
by concerns at the Securities and Exchange Commission, the Sarbanes-Oxley Act,
and the Auditing Standards Board and International Auditing and Assurance Standards
Board issuance of proposed standards on materiality. This paper: (1) reviews and integrates the empirical research on materiality since 1982, and (2) suggests some implications of this research for audit practice and research. The review indicates that
while many issues related to materiality have been addressed by prior research, a
number of new and important areas are in need of further examination.
Keywords: materiality; materiality bases; quantitative; qualitative materiality factors.
INTRODUCTION
ateriality has been and continues to be a topic of importance for auditors. The
most recent controversy started when Securities and Exchange Chairman Arthur
Levitt expressed concern over the concept of materiality in financial reporting
and auditing in his Numbers Game speech (Levitt 1998). He argued that companies and
their auditors were abusing the concept of materiality in order to manage earnings.
Commissioner Levitt stated that:
some companies misuse the concept of materiality. They intentionally record errors within
a defined percentage ceiling. They then try to excuse that fib by arguing that the effect on
the bottom line is too small to matter. If thats the case, why do they work so hard to create
these errors? Maybe because the effect can matter, especially if it picks up that last penny
of the consensus estimate. When either management or the outside auditors are questioned
about these clear violations of GAAP, they answer sheepishly ... It doesnt matter. Its
immaterial.
William F. Messier, Jr. is a Professor at Georgia State University and Professor II at the
Norwegian School of Economics and Business Administration, Nonna Martinov-Bennie is
a Lecturer at The University of New South Wales, and Aasmund Eilifsen is a Professor at
the Norwegian School of Economics and Business Administration.
We thank Dick Bernardi, Karen Braun, Joe Carcello, Jeff Cohen, Mike Gibbins, Audrey Gramling, Bill Kinney
(Associate Editor), Mark Nelson, Peter Roebuck, and Brad Tuttle for their helpful comments.
Submitted: January 2005

Accepted: June 2005
153
154
Messier, Martinov-Bennie, and Eilifsen

In markets where missing an earnings projection by a penny can result in a loss of
millions of dollars in market capitalization, I have a hard time accepting that some of these
so-called non-events simply dont matter.
Commissioner Levitt instructed the Securities and Exchange Commission (SEC) staff to
examine this problem and develop guidance to consider qualitative factors for determining
materiality. The SEC (1999) issued Staff Accounting Bulletin (SAB) No. 99, Materiality,
which states that strict reliance on quantitative measures to assess materiality is inappropriate. SAB No. 99 requires auditors to consider qualitative factors (e.g., the effect of the
item on meeting consensus forecasted earnings, trend in earnings) in determining materiality.1 To respond to the concerns of the SEC, the largest public accounting firms formed
the Big Five Audit Materiality Task Force and issued a report in October 1998 (Big Five
Audit Materiality Task Force 1998).
The work of the task force resulted in the issuance of Statements on Auditing Standards
(SAS) No. 89 and No. 90 (AICPA 2004a) by the Auditing Standards Board (ASB). SAS
No. 89 requires that the auditor have management sign-off on waived adjustments while
SAS No. 90 requires that the auditor present any waived adjustments to the companys
audit committee. The intent of these standards is to require management and audit committees to take responsibility for misstatements detected that are not booked.
Additional concerns related to materiality have resulted from the Public Company Accounting Oversight Boards (PCAOB 2004) Auditing Standard No. 2 (AS No. 2) on reporting on internal control. This standard requires management and their auditors to consider materiality when deciding which controls to test. More importantly, it requires
management and their auditors to consider materiality when assessing whether a control
deficiency is a significant deficiency or a material weakness. (See A Framework for Evaluating Control Exceptions and Deficiencies, Version 3, [AICPA 2004b].) Finally, the ASB
and International Auditing and Assurance Standards Board (IAASB) have issued exposure
drafts that will revise existing guidance on materiality (AICPA 2005a; IAASB 2004).2
With this renewed interest in materiality by regulators and standard setters, we believe
that it is appropriate to examine the state of research on materiality. Therefore, this paper
has two objectives: (1) to review and integrate the empirical research on materiality since
the Holstrum and Messier (1982) review3 and (2) to identify the implications of this research
for audit practice and research.
The remainder of the paper is as follows. In the next section, we provide a background
discussion on the concept of materiality and its application by auditors. This is followed
by a brief summary of materiality research conducted prior to 1982 and reviewed by
Holstrum and Messier (1982). Our review of materiality research subsequent to 1982 follows that section. The next section presents a summary of this research and suggests areas
for future research. The last section contains some concluding comments.
Note that intentional immaterial misstatements by management have always been prohibited by the securities
acts.
Since April 2003, the PCAOB has the authority to issue auditing standards for registered (public) companies.
Thus, the ASBs standards apply only to private companies. At the current time, the PCAOB does not have
materiality listed as a current agenda item.
The literature review is limited to published scholarly research papers. We provide no coverage of professional
and practitioner articles.
Auditing: A Journal of Practice & Theory, November 2005
A Review and Integration of Empirical Research on Materiality: Two Decades Later
155
BACKGROUND
Materiality Defined
Materiality is a key concept in both the theory and practice of accounting and auditing.
The importance of this issue is summarized in Financial Accounting Standards Boards
Discussion Memorandum (FASB 1975, 3):
The concept of materiality pervades the financial accounting and reporting process. It influences decisions regarding the collection, classification, measurement, and summarization of
data concerning the results of an enterprises economic activities. It also bears on decisions
concerning the presentation of that data and the related disclosures in financial statements.
As applied by preparers and auditors, the concept of materiality is generally understood
ultimately to involve determination of the importance of a matter for financial reporting
purposes.
The concept of materiality has been defined by the FASB in Statement of Financial Accounting Concepts No. 2 (FASB 1980, 132) (and included in SAS No. 47, AU 312.10)
as:
The omission or misstatement of an item is material in a financial report, if, in light of
surrounding circumstances, the magnitude of the item is such that it is probable that the
judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of an item.
The SECs definition of materiality is very similar with the user defined as an average
prudent investor [who] ought to reasonably be informed about before purchasing the security registered.
The IAASBs exposure draft on materiality (IAASB 2004) relies on the International
Accounting Standards Boards (IASB) definition:
Omissions or misstatements of items are material if they could, individually or collectively,
influence the economic decisions of users taken on the basis of the financial statements.
Materiality depends on the size and nature of the omission or misstatement judged in the
surrounding circumstances. The size or nature of the item, or a combination of both, could
be the determining factor.
An important difference between the two definitions is that the FASB definition relies on
whether the magnitude of the item is probable in affecting the users judgment while the
IASB definition uses the term could influence the users judgment. U.S. standard setters
have expressed concern that the use of the word could without a modifier such as reasonably, establishes a very low threshold of materiality in light of the fact that the word
could implies a potentially endless number of possibilities. If the auditor is to design an
audit to detect what could influence the economic decisions of users, this may impose an
unreasonable and impractical instruction to the auditor, especially when dealing with the
needs of users of general purpose financial statements (AICPA 2005b, emphasis added).
The AICPAs concern is likely the result of the legal environment in the U.S.
Holstrum and Messier (1982, 48) pointed out three main problems with a user approach
to materiality. First, little is known about how financial statement information is utilized by
users in investment and credit decision making. Second, materiality decisions are made
by preparers, auditors, and users; these heterogeneous groups are likely to have dissimilar
views of materiality because of their different incentives. Third, there is little information
on how materiality judgments made by preparers and auditors affect users decisions. These
same problems with a user perspective continue to be relevant after two decades.
156
Materiality and the Audit Process

The concept of materiality is important throughout the audit process, but is particularly
relevant to planning the audit and in evaluating the results of audit testing.4 The assessment
of what is material at each of these phases of the audit is a matter of professional judgment.
At the planning phase, the auditor determines an overall magnitude of materiality (for
financial statements as a whole) that is used to develop the scope of the audit. This materiality amount is typically referred to as planning or audit materiality (Big Five Audit
Materiality Task Force 1998; Holstrum and Messier 1982). Generally, auditors allocate
a portion of the planning materiality to account balances or classes of transactions. This
allocated amount is referred to as tolerable misstatement, and represents the amount by
which the account or class of transactions can be misstated and not be considered material.5
At the completion of the audit, detected misstatements are compared to tolerable misstatement in order to determine if these misstatements are material enough to require adjustment
of the clients books. This part of the process is typically referred to as evaluation
materiality (Big Five Audit Materiality Task Force 1998). Auditing standards indicate that,
theoretically, planning materiality should be similar to evaluation materiality if it was based
on the same information available at the planning stage (AU 312.22).
The Big Five Audit Materiality Task Force concluded that the practice issues related
to materiality, for the most part, involved evaluation materiality and not planning materiality.
Thus, the task force believed that it is the application of appropriate audit judgment to the
evaluation of the significance of detected misstatements that is the problem and not
the level of materiality used to plan the scope of audits. A good example of this issue
is the $51 million adjustment that was waived by Arthur Andersen on Enrons 1997 audit.
Andersen argued that this amount was not material, using an average of annual reported
earnings (Berardino 2001). While various government sources were critical of this materiality judgment, Brody et al. (2003) show that much of the professional materiality guidance supports Andersens decision to waive the adjustment as immaterial.
MATERIALITY RESEARCH PRIOR TO 1982
A significant amount of research was conducted in the 1970s that addressed different
aspects of the materiality concept. Interest in materiality was intensified by the FASBs
decision in 1975 to examine this issue (FASB 1975). Holstrum and Messier (1982) presented a detailed review of the materiality literature prior to 1982. They summarized their
findings under four areas: (1) the nature of the item, (2) the structural form of the decision
model, (3) the relative importance of factors used to determine materiality, and (4) materiality thresholds.
The Nature of the Item
Because of the diversity of items examined in prior research (e.g., extraordinary items,
change in depreciation and tax method, and qualified audit reports), Holstrum and Messier
(1982) concluded that it was difficult to integrate the results of the reviewed research. This
finding is significant because there is evidence that the nature of the item is an important
4
The process outlined here would be applicable to an integrated audit conducted under PCAOB standards that
includes reporting on internal control over financial reporting.
There are a number of ways in which firms convert planning materiality to tolerable misstatement (see AICPA
2001; Messier et al. 2006, Chapter 3). For example, the AICPA (2001) suggests applying a multiplier in the
range of 5075 percent to the overall materiality amount.
157
determinant of materiality, and it is likely that the relative importance of such items varies
significantly.
The Structural Form of the Decision Model
A considerable amount of behavioral research on materiality has found that auditors
judgments can be modeled using an additive (linear) model. For example, Messier (1983)
found that a linear model accounted for most of the variance in audit partners materiality
judgments. However, there was some evidence that configural (nonlinear) processing occurred in the audit partners materiality judgments.
Relative Importance of Factors in Judging Materiality
The percentage effect of the item on income was the single most important quantitative
factor in determining materiality. A distant second in importance was the effect of the item
on earnings trend. Results for total assets or net assets were mixed. While Holstrum and
Messier (1982) pointed out that the measurement of relative importance of a particular
factor is dependent upon the range of experimental manipulation used by the researchers,
the result on relative importance of income appears to be very consistent with audit practice
guidance.
Materiality Thresholds
There were considerable differences between users, preparers, and auditors with respect
to materiality thresholds. In general, users demonstrated lower materiality thresholds than
preparers or auditors; the materiality thresholds for auditors tended to be between those of
preparers and users. Additionally, auditors from large national firms had higher materiality
thresholds than auditors from small firms. Last, differences were also found among auditors
from different large firms and even among the auditors within the same firm.
Summary
Holstrum and Messier (1982) concluded that the results of research up to 1982 did not
provide any definite comprehensive implications for audit practice or policy formulation.
Since that time there have been numerous changes in both the regulatory and professional
environments.
MATERIALITY RESEARCH SUBSEQUENT TO 1982
Based on our review of the materiality research conducted subsequent to Holstrum and
Messier (1982), relatively little research on materiality was published in the mid-1980s.
There was renewed interest in materiality in the late-1980s, most likely due to the adoption
of the audit-risk model into auditing standards and its integration by public accounting
firms into their audit methodologies. We discuss this research under two research methods:
archival studies and behavioral studies. In discussing the results, we focus our discussion
on the most representative research. The tables that accompany each section outline all
papers reviewed.
Archival Studies
Archival studies use audit firm manuals, data from auditor working papers, or published
financial statement data and auditor reports to examine materiality decisions. We discuss
these studies based on the source of the underlying data: auditor-related sources and public
sources.
158
Auditor-Related Sources
Audit firms manuals and working papers containing auditor-detected misstatements
have provided substantial evidence of auditors materiality judgments. Table 1 summarizes
each of these studies by source of the information or data.
Audit manuals. Steinbart (1987) relied on the manuals of ten audit firms and extensive
interaction with expert auditors to construct a rule-based expert system for making materiality decisions. The construction of the expert systems knowledge base involved learning
how various quantitative and qualitative factors entered into auditors planning materiality
judgments. Steinbart (1987) found that the planning materiality judgments involved two
separate sub-decisions: (1) the choice of an appropriate base (quantitative factor) for calculating materiality and (2) selection of a percentage rate for multiplying the base. The
choice of the percentage to apply to the base was much more subjective and depended on
information about intended use of the clients financial statements and the nature of the
audit engagement (i.e., specific situations representing increased business risk and the auditors preferred response to that risk). Finally, the prior years materiality level was used
to modify the resulting materiality amount.
Friedberg et al. (1989) examined audit manuals to determine and compare the guidance
provided by the firms for establishing materiality. They obtained the relevant sections of
the audit manuals from six of then Big 8 U.S. public accounting firms. Consistent with
previous research, the relationship of a misstatement to net income and the effect of a
misstatement on earnings trends were consistently included in the firms manuals as factors
that should be considered in making materiality judgments. However, the detailed quantitative guidelines and qualitative factors included in their guidance differed substantially
between firms.
Martinov and Roebuck (1998) performed a similar analysis nearly a decade later using
the materiality and audit-risk guidance from the Big 6 public accounting firms in Australia.
They corroborated their analysis through interviews with a senior representative from each
of the participating firms. Their findings are generally consistent with Friedberg et al.
(1989). The individual firms approaches to determining overall planning materiality differed significantly. For five of the firms, a considerable amount of judgment was involved
in setting planning materiality, although guidance was provided as to the appropriate base
and percentage range. Five of the firms also either implicitly or explicitly differentiated
between planning materiality and reporting materiality. All firms gave consideration to
materiality at the individual account and/or class of transactions level, normally as a function of the planning materiality. The level of judgment exercised by individual auditors in
setting tolerable misstatement at the account level varied significantly, with three of the
firms providing very little or no guidance and the other three prescribing a specific percentage of the overall materiality. The results of Martinov and Roebuck (1998) are relatively
consistent with Steinbart (1987).
Audit working papers. Studies that used audit working papers examined issues that
included auditors materiality decisions at the planning stage (Blokdijk et al. 2003) and
evaluation stage (Robinson and Fertuck 1985), the effect of materiality on auditors decisions to book or waive adjustments (Icerman and Hillison 1991; Wright and Wright 1997),
and the effect of materiality on auditors decision to project misstatements (Allen and Elder
2005; Elder and Allen 1998).
Blokdijk et al. (2003) examined a sample of 108 Dutch Big 5 and non-Big 5 audit
engagements for the years 199899. They found that although planning materiality increases with client size, it increases at a decreasing rate (similar to nonlinear relationship
Studies
Scope
Research Issue(s)
Major Findings
Panel A: Studies Based on Information from Audit Manuals

Steinbart (1987)
Construction of a rules-based
expert system for making
planning-stage materiality
judgments and how various types
of information influence those
judgments.
Audit manuals obtained from six of

the then Big 8 firms in U.S.
Guidelines in audit manuals about

quantitative and qualitative
factors used to judge materiality.
The planning-stage materiality judgments
Martinov and
Roebuck (1998)
Analysis of audit manuals, other

relevant decision aids, and
interviews with the technical
partner or manager from each of
the Big 6 firms in Australia.
Analysis of how materiality

assessments are made and
integrated.
were seen to involve two separate subdecisions: (1) choice of an appropriate base
for calculating materiality and (2) selection
of a percentage for multiplying the base.
The base was shown to depend on
information about the perceived needs of the
financial statements users and objective
characteristics of the client.
The percentage rate depended on information
about intended use of the clients financial
statements and the nature of the audit
engagement.
The relationship of a misstatement to net
income and the effect of a misstatement on
earnings trends were consistently mentioned
as affecting quantitative and qualitative
materiality, respectively.
The quantitative and qualitative guidance
provided by the firms differed substantially.
Although all the firms set an overall
planning materiality, diversity existed in
relation to level of guidance and judgment
involved, the actual guidelines used, and the
utilization of additional materiality levels
such as an account-level materiality.
(continued on next page)
159
Friedberg et al.
(1989)
Audit manuals of ten U.S. audit

firms, interviews with four of
these firms, a number of
interactive sessions with one audit
partner (involved in the
construction of the expert system),
and responses of six auditors (in
testing the expert system on 13
clients).
TABLE 1
Summary of Archival Studies on Materiality
Auditor-Related Sources
160
TABLE 1 (continued)
Studies
Scope
Research Issue(s)
Major Findings
Panel B: Studies Based on Information from Audit Working Papers

Data from work papers on 610
materiality decisions for 61
Canadian companies that were the
prime responsibility of 15 partners
from three audit firms.
The study attempts to identify

factors that determine auditor
evaluation materiality judgments.
Icerman and
Hillison (1991)
1,424 detected misstatements in 147

audits of seven U.S. Big 8 firms.
The sample consisted of 49
manufacturing companies for the
years 19791981.
368 misstatements of 186 clients of
Peat, Marwick, Mitchell & Co.
(U.S.) for 198485.
Materiality judgments as reflected

in the decision to book or waive
detected misstatements.
235 sampling applications for 64

audits by two U.S. Big 6 firms
and one large regional public
accounting firm for 199394.
Auditors decision to quantify

misstatements by projecting
them to the population.
Wright and
Wright (1997)
Elder and Allen

(1998)
Examine variables that may explain

the decision to waive detected
misstatements.
The effect of the misstatements on net
income was significant in their decisions, but

it was not the only relevant factor.
Objectively verifiable misstatements are more
likely to be material, as are misstatements in
companies where the client opposes the
adjustments.
Contrary to expectations, misstatements are
less likely to be declared material in high
debt-ratio companies.
The decision to book or waive detected
misstatements was a function of relative
misstatement size (percentage of net
revenues) and audit firm structure.
Materiality (misstatement amount relative to
planning materiality) appeared to be an

important factor in deciding whether to
waive detected misstatements.
The decision to book or waive a detected
misstatement entails multiple factors in
addition to materiality such as impact on
income, nature of the misstatement, and size
of the client.
Auditors decision to project misstatements
was affected by materiality.
Misstatement immateriality was the most
common reason for not projecting a
misstatement.
Robinson and
Fertuck (1985)
Panel B: Studies Based on Information from Audit Working Papers, continued

Allen and Elder
(2005)
Compare these results to the error

projection decisions from 1994
to 1999.
Planning materiality judgments from

108 audit engagements from 13
Dutch audit firms (the Big 5 and
8 non-Big 5) for the years
199899.
Investigate the planning materiality

values used by auditors in The
Netherlands.
Immateriality continued to be a main reason

for not projecting misstatements.
There were significant changes in the extent
to which individual firms used materiality as

a justification not to project errors. One firm
increased the use immateriality for not
projecting misstatements while another firm
decreased immateriality as a reason for not
projecting.
Planning materiality increased with client
size, but at a decreasing rate.
Planning materiality increased with the
auditors assessment of the quality of the
control environment and the magnitude of
the clients rate of return, and decreased with
auditors assessment of client complexity.
Other examined variables (current ratio,
inherent risk, illegal acts, leverage, listed,
audit firms tenure by the client, and risk
approach) were not significantly related to
planning materiality.
Big 5 auditors planning materiality judgment
were lower than non-Big 5 auditors.
When reported earnings are around zero,
auditors use lower planning materiality.
161
Blokdijk et al.
(2003)
200 sampling applications for 53

audits in fiscal year 1999 or 2000.
The 1999 sample includes 35
clients common to the earlier
period and an additional 18 clients
that had not been tested in the
earlier period.
TABLE 1 (continued)
162
in KPMGs gauge6). Blokdijk et al. (2003) also reported that planning materiality increases
with the auditors assessment of the quality of the control environment and the magnitude
of the clients rate of return, and decreases with auditors assessment of client complexity.
Other variables considered such as current ratio, inherent risk, illegal acts, leverage,
exchange listing, audit firms tenure by the client, and risk approach were not significantly
related to planning materiality. Blokdijk et al. (2003) found that Big 5 auditors assess
planning materiality at a lower level than non-Big 5 auditors (cf., Messier 1983). Finally,
the study found that when reported earnings are around zero, auditors use lower planning
materiality.
Robinson and Fertuck (1985) examined how auditors made evaluation materiality decisions by investigating data from audit files of 610 materiality decisions. Their sample
included 61 Canadian companies from three public accounting firms. Robinson and Fertuck
(1985) report that (1) the effect of the misstatements on net income was significant in
materiality decisions, but it was not the only relevant factor, (2) objectively verifiable (no
judgment required) misstatements were more likely to be material, as were misstatements
in companies where the client opposes the corrections, and (3) misstatements were less
likely to be declared material in high debt-ratio companies.
Two studies (Icerman and Hillison 1991; Wright and Wright 1997) examined how
auditors decisions to book or waive detected misstatements were affected by materiality.
Icerman and Hillison (1991) examined a sample 1,424 misstatements from 49 manufacturing companies for 19791981. They reported that the decision to book or waive a misstatement was a function of the misstatement as a percent of net revenue and audit firm
structure (see Kinney 1986). Firms with structured audit approaches (e.g., KPMG) tended
to book a greater proportion of the individual misstatements than less structured firms.
Thus, a firms audit methodology is likely to impact auditors materiality judgments.7
Wright and Wright (1997) also examined factors affecting auditors decisions to waive
detected misstatements. They examined 368 misstatements from 186 Peat, Marwick,
Mitchell & Co. (now KPMG) clients. Consistent with prior studies, Wright and Wright
(1997) reported that the magnitude of the misstatement relative to planning materiality was
the most important factor in deciding to waive detected misstatements.8 Other factors that
affected the decision to book or waive the misstatements include the directional impact on
income, the nature of the adjustment (objective cause versus a subjective cause), and client
size.
Elder and Allen (1998) examined whether detected misstatements are projected as required by auditing standards. They examined 235 sampling applications for 64 audits of
two Big 6 firms and one large regional firm. Elder and Allen (1998) found that the decision
to project a misstatement was related to several factors, including materiality of the misstatement (the projected misstatement as a percentage of planning materiality), direction of
the misstatement, type of test detecting the misstatements, and audit firm characteristics.
The immateriality of the misstatement was the most common documented reason for not
projecting a misstatement. This result is disturbing since, as noted by the authors, it would
6
Gauge is KPMGs measure of materiality and it is a nonlinear function of assets or revenues. Elliott (1983, 4)
reported gauge as 1.6 (the greater of assets or revenues)2 / 3. It is our understanding that his formula varied
by industry and country.
Since Kinneys study in 1986, all of the major firms have revised their audit methodologies. It is no longer used
by KPMG but it is an open question whether there are differences in the current structure of large firms
methodologies.
Nelson et al. (2002), in a questionnaire survey of auditors, found that auditors often justified waiving adjustment
due to immateriality.
163
appear that the materiality of a misstatement cannot be determined until it has been projected (Elder and Allen 1998, 74).
In a follow-up study, Allen and Elder (2005) collected 200 sampling applications for
53 audits in fiscal year 1999 or 2000 (hereafter the 1999 sample). The sample included 35
clients common to the earlier study, and an additional 18 clients that had not been tested
in the earlier period. They found that there was little change in the extent to which materiality is used to justify the failure to project errors (46 percent of nonprojected errors were
considered immaterial in the 1994 sample versus 44 percent in the 1999 sample). The
findings are similar for the matched sample of audits. However, there were significant
changes in individual firm behavior in using materiality as a justification to not project
errors. One firm had a significant decrease in using immateriality as a justification not to
project errors while another firm had a significant increase.
Summary. Research that has relied on firm manuals and working papers has identified
a number of significant findings. First, there appears to be differences in the way firms
establish planning materiality (Martinov and Roebuck 1998) with judgment playing a significant role. Second, some version of income continues to be the major factor in determining the materiality of a misstatement. Last, the immateriality of a misstatement is the
major factor in waiving potential misstatements.
Public Sources
Studies relying on publicly available data have investigated a wide range of financial
reporting items and disclosure issues. Such studies generally examined corporate annual
reports to determine if the disclosure of an accounting change and/or auditors consistency
qualifications can provide some boundaries on thresholds for materiality judgments. The
disclosed amount of the accounting change is used as a surrogate for the auditors and/or
preparers implied materiality decision.9
Among the diversity of financial reporting items and disclosure issues examined are
accounting for capitalization of interest costs (e.g., Morris et al. 1984), inflation accounting
disclosure (Frishkoff and Phillips 1985), foreign currency translation (e.g., Chewning et al.
1989), contingency disclosure (e.g., Fesler and Hagler 1989), LIFO disclosure (e.g.,
Wheeler et al. 1993), accounting for income taxes (Costigan and Simon 1995), equity-fordebt swaps (Chewning et al. 1998), and cost of postretirement benefits other than pensions
(Liu and Mittelstaedt 2002). A number of these studies also investigated the effect of the
change in accounting principle on the auditors consistency exception opinion (Morris et
al. 1984; Morris and Nichols 1988; Chewning et al. 1989; Wheeler et al. 1993; Costigan
and Simon 1995).10 In addition, Kinney et al. (2002) addressed the materiality of earnings
surprise as measured by stock prices. Table 2 provides a summary of these studies.
Frishkoff and Phillips (1985) investigated auditors materiality judgments using inflation
reporting by U.S. banks under SFAS No. 33, Financial Reporting and Changing Prices.
SFAS No. 33 required current cost information to be disclosed only if the current value
figures were materially disparate from historical-based data (i.e., material differences between the amount of income from continuing operations on a historical/constant dollar
basis and the amount of income from continuing operations on a current cost basis).
Frishkoff and Phillips (1985) reviewed annual reports of the 201 largest U.S. commercial
9
10
As observed by Holstrum and Messier (1982), such studies cannot distinguish the auditors materiality judgment
from the preparers materiality judgment. It is likely that the auditor and preparer negotiate the final materiality
threshold (Gibbins et al. 2001).
In 1988, auditing standards (SAS No. 58) removed the consistency qualification and replaced it with an unqualified opinion that included an explanatory paragraph describing the change in accounting.
164
TABLE 2
Summary of Archival Studies on Materiality Based on Publicly Available Information
Studies
Morris et al.
(1984)
Scope
Research Issue(s)
Audit reports and financial statement

data for 221 U.S. firms that
initially adopted SFAS No. 34,
Capitalization of Interest Costs, in
19791981.
Differences in absolute and relative

size and degree of overlap of
distribution of subsamples where
auditors judged the effect of
interest capitalized material or
not.
Major Findings
For the absolute dollar amounts of interest
Morris and
Nichols (1988)
Annual reports for 201 large U.S.

commercial banks and bank
holding companies supplemented
by questionnaire data covering
adoption of SFAS No. 33,
Inflation Accounting Disclosure.
The relationship between publicly

available financial information
and auditors materiality
judgments as signaled by
consistency exception opinions.
Degree of consensus of materially
judgments across Big 8 firms.
Correlation between materiality
judgment and audit firm
structure.
The importance of materiality in
the banks decision to report
inflation accounting data.
Banks that did not report current cost
information did so on the basis of the

information being immaterial.
Materiality was not the deciding factor for
banks that reported current cost information.
Frishkoff and
Phillips (1985)
Audit reports and financial statement

data for 334 publicly traded
companies that initially applied
SFAS No. 34, Capitalization of
Interest Costs, in 19791981.
capitalized, the mean was smaller and

coefficient of variation was greater for the
immaterial changes.
Companies receiving a qualified report had
mean ratios (interest capitalized as a percent
of net plant) over two and one-half times
larger than the companies receiving an
unqualified report.
The frequency distribution of the ratios for
the two groups had considerable amounts of
overlap.
The publicly available financial information
measures explained a significant portion of
the variability in auditor materiality
judgments.
Significant differences in judgment consensus
were found between the Big 8 firms.
There was a significant positive correlation
between judgment consensus and audit firm
structure.
Audit opinions and financial

statement data from 198083 for
284 U.S. companies that adopted
LIFO, and initially applied SFAS
No. 52, Foreign Currency
Translation, and SFAS No. 43,
Compensated Absences.
Wheeler et al.
(1993)

statement data from 198087 for
563 U.S. companies that adopted
LIFO, and initially applied SFAS
No. 52, Foreign Currency
Translation, and SFAS No. 43,
Compensated Absences.
The propensities to modify audit

opinions for a change in
accounting principles as a
function of the effect on income.
The effect of type of accounting
change (discretionary versus
nondiscretionary) on the
frequency of audit report
modifications.
The effect of other hypothesized
variables on the frequency of
audit report modification.
The propensities of audit firms to
modify audit opinions for a lack
of consistent application of
accounting principles.
Consistency modifications were issued at a
much smaller effect on income than

suggested by previous research.
The discretionary change (LIFO adoption)
resulted in a significantly higher percentage
of modified opinions than the
nondiscretionary changes (foreign currency
translation and compensated absences).
Limited evidence that Big 8 firms have
higher materiality thresholds than non-Big 8
firms.
Substantial between-audit firm consensus for
Fesler and Hagler

(1989)
Financial statements disclosure in

1982-83 for 126 lawsuits lost
under SFAS No. 5, Contingencies,
from 19751982 by U.S. publicly
traded companies.
Litigation disclosure at various

materiality levels.
opinion modifications when accounting

changes produced traditionally material
effects.
Substantial between-audit firm differences in
propensities to modify audit opinions when
accounting changes produced effects
normally considered immaterial.
Relative litigation experiences, but not audit
firm structure, were significant in explaining
between-Big 8 firms differences to modify
audit opinions specifically stated to be
immaterial.
Non-Big 8 firms exhibited a significantly
higher tendency than Big 8 firms to modify
their opinions.
Nondisclosure of litigation contingencies is
common, even at relatively high materiality
levels.
Disclosure of litigation contingencies
improves significantly with increasing
materiality levels.
165
Chewning et al.
(1989)
TABLE 2 (continued)
166
TABLE 2 (continued)
Studies
Pany and Wheeler
(1989)
Costigan and
Simon (1995)
Scope
Financial statement data for 330
U.S. companies representing 25
industries for 19771986.

statement data of 351 U.S.
companies that were early
adopters of SFAS No. 96,
Income Taxes.
Research Issue(s)
Major Findings
Apply various rules of thumbs for

quantifying planning materiality
to industry data to identify
differences in sizes and stability
of the resulting measures within
and among industries.
Applying various rules of thumbs resulted in
Factors that triggered audit firms to

modify audit opinions for a lack
of consistent application of
accounting principles.
Gleason and Mills

(2002)
Financial statements disclosure of

contingent tax liabilities under
SFAS No. 5 from 19871995 and
IRS audited data from 19811995
for 100 U.S. industrial companies.
Materiality decisions inferred by

disclosure of contingent tax
liabilities.
sizable differences depending upon method

and industry.
There were large differences in stability of
calculated materiality amounts within and
among industries.
Blended methods and audit gauge were the
most stable methods across industries.
In addition to the magnitude of financial
statement effects, auditors materiality
judgments were sensitive to the method of
implementing adoption of SFAS No. 96
(cumulative versus retroactive treatment).
Client-firm size positively affected auditors
decision to modify.
No difference in materiality judgments
between Big 8 firms and non-Big 8 firms,
but there were significant differences
between structured and less-structured Big 8
firms.
The litigation experience among Big 8 firms
did not explain differences in materiality
judgments.
IRS claims exceeding 5 percent of income
were not always disclosed.
The probability of disclosure increased with
the relative amount of the claim.
Firms determined materiality with respect to
firm size rather than current-year income.
Materiality is based on normal income
(the greater of income or 5 percent of assets)
when the firm reports low income or a loss.
Liu and
Mittelstaedt
(2002)
Kinney et al.
(2002)
Evaluate expense amounts

designated immaterial under
SFAS No. 81.
Financial statement data for 154

individual U.S. firm-swap years
for 198184.
Relationship between frequencies

of auditors extraordinary gain
classification to the relative
effect on income for equity-fordebt swaps.
Relationship between income
statement classification of gains
and the strength of the capital
markets reaction of swap
announcements.
Materiality of earnings surprises as
measured by stock prices.
Earnings forecasts and stock return

data (U.S.) for 199297.
The material-immaterial decision was
positively related to materiality measures

based on cost of postretirement benefits.
The material-immaterial decision was not
consistent across firms.
The material-immaterial decision was also
related to factors identified in the voluntary
disclosure literature.
Auditors materiality decisions follow closely
the conventional percentage-of-income ruleof-thumb.
There was a positive association between
income statement classification of gains and
the strength of the capital markets reaction
of swap announcements.
Earnings surprises alone are not material to

an investor for an individual security.
167
Chewning et al.
(1998)
Financial statements information for

437 U.S. firms that were reporting
in 1989 under SFAS No. 81,
Disclosure of Postretirement
Health Care and Life Insurance
Benefits.
TABLE 2 (continued)
168
banks and bank holding companies, supplemented by a questionnaire requesting information

on the banks decision to report inflation accounting data. One hundred seventy-six banks
reported only historical/constant dollar amounts in their annual reports. Fifteen banks reported current cost (and constant dollar amounts). The remaining ten banks were not
required to report inflation information under SFAS No. 33, and either did not report or
used gross national product deflator values. These findings indicated that materiality was
not the deciding factor for the 15 banks that reported current cost in their annual reports.
However, the banks that did not report current cost did so on the basis of immateriality.
One of the first studies to examine auditors reporting decisions was Morris et al.
(1984). They investigated auditors reporting decisions for firms initially applying SFAS
No. 34, Capitalization of Interest Costs. Auditing standards in effect at the time (SAS No.
2) required that if a change in accounting principle had a material effect on the financial
statements, then the auditor should issue a qualified (except-for) opinion for a lack of
consistency in application of an accounting principle. Morris et al.s (1984) sample consisted
of 221 firms initially applying SFAS No. 34 for 19791981. Sixty-nine firms received
qualified opinions and the researchers concluded that the change in accounting principle
for those firms was considered material by the auditors. Morris et al. (1984) report the
following main results. First, using the absolute dollar amount of interest capitalized,
the mean was smaller and the coefficient of variation (the ratio of standard deviation to the
mean) was greater for the firms that received an unqualified report. Second, the firms that
received a qualified audit report had mean financial ratios (interest capitalized relative to
net income and interest capitalized relative to net property, plant, and equipment) greater
than 2.5 times those of the firms that received an unqualified audit report. Third, superimposing the frequency distribution of interest capitalized as a percent of net plant revealed
considerable amounts of overlap for the two groups of companies.
Morris and Nichols (1988) extended Morris et al. (1984) using a sample of 334 clients
of Big 8 firms that initially applied SFAS No. 34 during 19791981. They found that nine
publicly available financial information measures11 explained a significant portion of the
variability of the auditors materiality judgments and that the consistency exception decision
varied significantly between Big 8 firms. Finally, a significant positive association was found
between audit judgment consensus and the degree of audit firm structure (Kinney 1986).
Chewning et al. (1989) focused on changes in accounting principle resulting from
adoption of LIFO (APB No. 20), and the initial application of SFAS No. 43, Compensated Absences, and SFAS No. 52, Foreign Currency Translation. They were interested in
testing whether materiality decisions for discretionary accounting changes (LIFO adoption)
differed from nondiscretionary accounting changes (compensating absences and foreign
currency translation). They found that the importance of the effect of the change on income
was the most significant factor to the auditors materiality judgments. Chewning et al.
(1989) also found that report modifications were more frequent for discretionary change.
Finally, limited evidence suggested that Big 8 firms were less likely to modify their opinions
than non-Big 8 firms.
11
These measures were interest capitalized divided by net income, net sales, total assets, net property, plant, and
equipment, and net worth, respectively, debt-to-equity ratio, net income-to-equity ratio, percentage change in
income from the year immediately prior to disclosure of initial application of SFAS No. 34, and market value
of equity calculated at the end of the fiscal year in which SFAS No. 34 was initially applied.
169
In a related paper, Wheeler et al. (1993) examined between-audit firm differences in

propensities to modify audit reports using the same three accounting events. After controlling for client financial condition,12 their results indicated that there was high between-firm
consensus for opinion modification when the accounting change produced income effects
traditionally considered as material (i.e., at least 4 percent effect on operating income).
However, they observed that non-Big 8 firms modify their opinions more often than Big 8
firms when the accounting change produced immaterial effects (i.e., less than 4 percent on
operating income). Last, relative litigation experience was significant in explaining the
differences among Big 8 firms in their propensities to modify audit opinions specifically
stated to be immaterial.13
Studies by Fesler and Hagler (1989), Gleason and Mills (2002), Costigan and Simon
(1995), and Liu and Mittelstaedt (2002) also used accounting changes to examine auditors
materiality reporting decisions. Not surprisingly, in some cases their results support some
of the prior findings. In other cases, their findings are inconsistent with prior studies. For
example, Costigan and Simon (1995) found that structure explains differences in the materiality judgments of Big 8 firms (see footnote 7), but that there is no difference in
materiality judgments between Big 8 and non-Big 8 firms.
Chewning et al. (1998) extended prior archival research by focusing on the reported
gains and losses for equity-for-debt swaps and the stock market reactions to the announcement of swap transactions. SFAS No. 4 required gains and losses from the extinguishment
of debt to be classified as extraordinary items if material. Their sample of swap transactions
included 154 individual firm-swap years for the period August 1, 1981 through June 30,
1984. Chewning et al. (1998) observed that auditors materiality decisions closely followed
the conventional percentage-of-income rule-of-thumb. This contrasted with prior findings
(e.g., Morris et al. 1984; Chewning et al. 1989) that indicated that consistency modifications
were issued at much lower percentages of income than conventional percentage-of-income
rule-of-thumb. Further, they documented a positive association between income statement
classification of gains and the strength of capital market reaction to the swap announcements. In combination, these two findings indicate that auditors following conventional
percentage-of-income rule-of-thumb would, on average, correctly classify transactions having greater market impacts as material and those transactions having significantly smaller
market impacts as immaterial.
Kinney et al. (2002) examined the materiality or importance-to-investors of earnings
surprises as measured by stock prices. Their study was motivated by Commissioner Levitts
speech about the abuse of the materiality concept to manage earnings (Levitt 1998).
Using First Call and CRSP stock return data for 199297, Kinney et al. (2002) defined an
earnings surprise14 as material if it was associated with a significant market reaction at the
individual firm level. The results show that an investor who trades a security based solely
on foreknowledge of the magnitude of the firms earnings surprise has less than two-thirds
chance for a profit. Kinney et al. concluded that knowledge of earnings surprise alone is
12
13
14
The companies financial condition was measured using Zmijewskis (1984, 69) financial distress prediction
model coefficients.
This was measured as each audit firms meritorious lawsuit cases for public clients expressed as a percentage
of total public-client audits (Palmrose 1988).
Earnings surprise is measured as actual EPS reported by First Call minus the consensus as of the last First Call
update before announcement of earnings for the year.
170
not important or material to an investor for an individual security, using our stock-pricebased materiality definition (Kinney et al. 2002, 1310).15 The lack of materiality is partly
due to the S-shape of the distribution of returns given earnings surprises (steeply sloped
for small absolute surprises and approximately flat for large absolute surprises), and large
return variation around the mean response for each level of surprise. The S-shape is related
empirically to the dispersion of analysts forecasts. Thus, factors underlying dispersion of
analyst forecasts are related to the materiality of the earnings surprise.
Summary. The archival-based research provides a number of conclusions. First, while
this research examined various reporting items and disclosures, the effect of the item on
income continues to be the most significant factor in auditors materiality and disclosure
decisions. This is consistent with the research that relied on auditor working papers. Second,
the choice to modify the auditors report seems consistent with traditional effects of the
item on income. Last, knowledge of an earnings surprise is not important to an investor in
an individual security.
Experimental Studies
Experimental studies have examined materiality judgments of users, auditors, and others
(judges/lawyers). Our review of the experimental studies is outlined based on the type of
participants included in the studies. Table 3, Panels AC summarizes these studies.
Users
Haka et al. (1986) conducted an experimental study that, among other things, addressed
the effect of materiality on functional fixation in terms of exposure to cost and income
measures in a decision-making setting where market value was the appropriate response.
Materiality level was manipulated as a percentage difference (at 2, 10, and 20 percent) of
the dollar difference between the sales price and cost. The responses of the 220 undergraduate participants indicate that materiality had an impact on the functional fixation and
stimulus encoding. The results imply that the larger the differences between the higher
purchase and higher sales price, the more likely that the decision maker would choose the
asset with the higher sales price. Furthermore, when materiality levels were higher, participants with more accounting training made more sales-priced-based decisions.
Fisher (1990) used an experimental markets approach to study the effect of the disclosure of materiality levels on users in terms of security prices, trading volume, and trading
profit. Graduate and undergraduate students (proxies for investors) participated in the repeated single-period, two-asset (cash and shares), double-auction markets in which the
information availability about the magnitude of materiality was manipulated (i.e., no disclosure versus private disclosure versus public disclosure). The results indicate that the
disclosure of materiality led to greater market efficiency. Public disclosure of materiality
appeared to be more useful than private disclosure.
Tuttle et al. (2002) investigated the appropriateness of common materiality thresholds
employed by auditors from a user perspective employing an experimental market approach.
Twelve market sessions were run, each with six traders and consisting of 12 independent
three-minute trading periods. Seventy-two undergraduate honors business students representing semi-sophisticated investors, were provided either with correctly stated financial
information, information containing immaterial misstatements or material misstatements.
15
They also observe that SAB No. 99s requirement that registrants and their auditors consider or forecast
significant market reactions conditional on some types of earnings surprise may be problematic in that it is
difficult to forecast even the sign of markets reactions with modest (0.667) level of confidence (Kinney et al.
2002, 1327).
Studies
Participants
Research Issue(s)
Major Findings
Panel A: Studies that Included Users as Participants

Haka et al. (1986)
Impact of materiality on wealth

maximization decision making.
Fisher (1990)
Business students
Tuttle et al. (2002)
Undergraduate
students
Whether disclosure of auditor materiality

levels would affect security prices,
trading volume, and trading profit.
Whether detected misstatements at or
below commonly applied materiality
thresholds result in market prices that
differ from prices based on correctly
stated information.
Examined audit committee members
responses to auditors materiality
justification and accounting issue
precision in contentious accounting
disagreements.
DeZoort et al. (2003)
Audit committee
members
The materiality of the difference between
the sales price and purchase price was

related to the number of sales-price driven
decisions (i.e., stimulus encoding appeared
to be contingent upon a materiality
threshold).
Disclosure of materiality resulted in more
efficient markets.
Misstatements within conventionally
employed materiality levels do not affect

users decisions.
Greater support for the auditors position
when the auditors materiality included

both quantitative and qualitative factors and
when the accounting issue was subject to
precise measurement.
Panel B: Studies that Included Auditors as Participants

Mayper (1982)
Senior auditors
Consensus of auditors assessment of

materiality of internal accounting control
weaknesses.
Moderate consensus between individual

auditors and among audit firms.
Consensus varied across different internal

accounting control weaknesses.
171
Undergraduate
students
TABLE 3
Summary of Behavioral Research on Materiality
172
TABLE 3 (continued)
Studies
Mayper et al. (1989)
Participants
Senior auditors
Research Issue(s)
Major Findings
The effect of probability and dollar

exposure on auditors internal accounting
control weaknesses materiality
judgments.
The auditors models indicated diversity in
Messier (1983)
Krogstad et al.
(1984)
Partners
Partners, seniors,
and auditing
students
The effect of experience, firm type, and

financial variables on auditors
materiality and disclosure judgments.
The role of financial and nonfinancial

information on auditors and students
materiality judgments.
Estes and Reames

(1988)
Wong-On-Wing
et al. (1989)
CPAs
Auditors
The effect of differences in auditors

personal characteristics on materiality
decision making and confidence in
materiality decisions.
The consequences of auditors perceptions

of management on subsequent
materiality thresholds judgments.
the importance of the independent variables

affecting the auditors materiality
judgments.
Both qualitative and quantitative factors
were considered.
The independent variables were, on
average, important in explaining auditors
Significant configural processing.
Net income was the most significant
variable with earnings trend next in
importance.
Consensus of auditors materiality and
disclosure judgments were affected by
experience and firm type.
Auditors focused primarily on the effect on
net income, but they also used various
nonfinancial information to fine-tune their
judgments.
Professional experience was a significant
factor.
Only two of the personal characteristics
studied (age and employment in public
accounting) produced significant
differences.
Personal characteristics exerted greater
influence on materiality decision
confidence.
Auditors materiality thresholds were
significantly associated with their inferences
about management.
Partners, managers,
and seniors
Carpenter et al.
(1994)
Partners, managers,
and seniors
Whittington and
Margheim (1993)
Managers
Bernardi and Arnold

(1994)
Managers and
seniors
Bernardi and Pincus

(1996)
Managers
Arnold et al. (2001)
Partners, senior
managers, and
managers
The significance of the size of the

transaction, the impact on earnings
trend, type of transaction, and auditor
experience on auditor materiality
judgments.
Whether auditor materiality judgments are
shaped by other contextual factors.
The impact of culture and auditor
experience on the formation of
The effect of materiality on external
auditors judgments about the extent of
the use of the internal auditor function.
The study examined the influence of
qualitative factors on auditors
materiality estimates.
Whether auditors quantitative materiality
judgments, based on ten common rules
of thumb, are affected by the prior risk
of fraud expectations, the evidence
examined, and post-audit risk of fraud.
The auditors materiality judgments were
The effect of client integrity, uncertainty

avoidance, and litigation on auditors
planning materiality estimates.
affected by the size of the item, its impact

on earnings trends, and the type of
transaction.
Experience influenced the use of qualitative
information to augment quantitative
assessment of the item.
Materiality judgments procedures were
influenced by the audit firms culture and
experience.
Materiality affected the assignment of test
of control work to internal auditors.
The results indicated that materiality
estimates were influenced by all of the

qualitative factors examined.
Majority of auditors set their materiality
judgments within the rules of thumb.
Auditors prior fraud expectations were not
related to their materiality judgments.
Amount of evidence examined or post-audit
risk of fraud did not lead to significant
differences in materiality judgments.
Lower client integrity resulted in lower
materiality estimates.
Higher uncertainty avoidance and
increasingly litigious environment resulted
in higher materiality estimates.
173
Carpenter and
Dirsmith (1992)
TABLE 3 (continued)
174
TABLE 3 (continued)
Studies
Participants
Libby and Kinney

(2000)
Managers
Braun (2001)
Partners and
managers
Ng and Tan (2003)
Partners and
managers
Whether quantitatively immaterial earnings

overstatement misstatements will be
recorded when the correction would
cause reported earnings to fall below
analysts consensus forecast.
Whether the implementation of SAS No.
89 would increase correction of
quantitatively immaterial detected
misstatements.
Whether book-or-waive decisions are
affected by the relative audit fees
received by the auditor, the clients
financial health, the subjectivity of the
proposed adjusting journal entry (PAJE),
the directional income effect of the
PAJEs, and the individual / aggregate
materiality of the PAJEs.
The effect of the availability of
authoritative guidance and the
effectiveness of the clients audit
committee on auditors perceived
outcome of auditor-client negotiations
concerning quantitatively immaterial
audit adjustment that affects the clients
ability to meet analysts forecast.
Whether auditors decisions to book
detected misstatements varies by the use
of the cumulative (iron curtain) method
or current-period (rollover) method for
evaluating detected misstatements.
Major Findings
Misstatements are less likely to be
corrected if they cause earnings to fall

below analysts forecasts.
SAS No. 89 had no effect on the correction
of such misstatements.
The book-or-waive decisions were not
affected by the clients relative fees but

were affected by the clients financial
health, the PAJEs subjectivity, and the
PAJEs aggregate directional effect on
income.
The auditors negotiation outcome
concerning the audit adjustment is jointly

influenced by authoritative guidelines and
audit committee effectiveness.
On average, auditors rated the materiality
of the audit adjustment to be moderate not
low, suggesting that the analysts forecast
was a factor in their materiality assessment.
The results indicate that across a number of
factors (e.g., misstatement size, subjectivity,
precision, and income effects, and whether
auditors document effects of their clients
quality of earnings) auditors are more
likely to book the misstatement under the
method that makes the misstatement appear
more material.
Nelson et al. (2005)
Managers
Research Issue(s)
Jennings et al.
(1987)
Auditors versus
judges / lawyers
The degree of consensus on various

disclosure issues both within and
between auditors and judges / lawyers.
There were significant differences in
Jennings et al.
(1991)
Auditors versus
judges / lawyers
(as proxy for
users)
Investigate the attitudes of auditors and

judges / lawyers toward materiality and
disclosure.
The judges / lawyers exhibited higher
materiality across different cases.
There was no consensus within each of the

groups.
standards of disclosure and expressed a

high level of agreement for explicit
quantitative standards on materiality.
175
Panel C: Studies that Involved Comparative Groups
TABLE 3 (continued)
176
Materiality level was manipulated at two levels: conservative materiality (based on the larger
of 5 percent of income before taxes or 0.25 percent of net sales) and liberal materiality
(based on the larger of 10 percent of income before taxes or 0.5 percent of net sales).
Comparisons of prices generated by market participants indicated that undisclosed misstatements within materiality thresholds that are consistent with current audit practice (i.e., at
or below materiality threshold) do not affect market prices, while large misstatements do.
DeZoort et al. (2003) examined whether the nature of the external auditors materiality
justification and the precision of the accounting issue underlying a proposed adjustment
affected audit committee members support for an auditors proposed adjustment. Fifty-five
public company audit committee members participated in the study and were asked whether
they supported the auditors position to record the proposed adjustment or managements
position not to record the adjustment. The accounting issue involved an increase in the
allowance for bad debts related to a customer bankruptcy subsequent to year-end where
the adjustment could be measured precisely or imprecisely. In the quantitative-only materiality condition the auditor argued for an adjustment because it represented 4.6 percent of
the companys pretax income (PTI), which, in their opinion, met their 5 percent of the PTI
materiality threshold. In the qualitative, consequences-oriented condition, the auditor supplemented this argument by linking it to the interruption of the EPS trend and possible
stock price reaction. The results showed that the audit committee members provided greater
support for the auditor when the auditors materiality justification included both quantitative
and qualitative consequences-oriented factors and when the accounting issue was subject
to precise measurement.
Auditors
Mayper (1982) examined the consensus of auditors assessment of the materiality of
internal accounting control weaknesses (IACWs) during the planning stage of the audit.
Thirty-eight senior auditors evaluated the materiality of 12 IACWs. Three independent
variables were manipulated: type of missing control (lack of segregation of duties or formal
authorization), type of asset affected (cash, dental supplies, and dental equipment), and
most likely dollar effect (80 percent or 20 percent of total dollars flowing through the
transaction area). The results indicated a moderate level of consensus for the materiality of
the IACWs. The mean correlation across participants, within firms, and between firms was
.45. There was also only a moderate level of agreement (73 percent) across participants as
to which of the 12 IACWs were material. The results also suggest that auditors may need
more structured criteria to make IACW materiality judgments for public disclosure and to
meet other legal requirements.
Mayper et al. (1989) reanalyzed the results of Maypers (1982) experiment using more
sophisticated statistical methods. They concluded that the auditors models indicated variability in the importance attached to the three independent variables (type of IACW, type
of asset, and likely dollar effect) and that the auditors considered both qualitative and
quantitative factors. For the majority of auditors, there was a significant interaction between
the type of IACW and the type of asset. Last, a majority of auditors showed significant
configural processing.
Messier (1983) analyzed a number of characteristics of auditor materiality/disclosure
judgments. Twenty-nine audit partners were presented with 32 cases and asked to make
two judgments: (1) the materiality of an inventory write-down and (2) the probability of
separate disclosure in the income statement. Net income was varied at four levels, while
earnings trend, total assets, total inventories, and current ratio each were manipulated at
two levels. The results indicate that net income was significant for virtually all partners (27
177
out of 29) and earnings trend was significant for approximately half of the participants.
The other three variables were generally not significant. Messier found that audit experience
and firm type were also significant. The less-experienced partners had lower materiality and
disclosure thresholds than more-experienced partners.16 Last, there was evidence of threshold differences between Big 8 and non-Big 8 auditors.
Krogstad et al. (1984) investigated the role of experience and the effect of financial
and nonfinancial information on auditors materiality judgments. Audit experience was varied by using three groups of participants: audit partners, audit seniors, and auditing students.
All participants completed 32 hypothetical cases requiring a materiality judgment for a
proposed adjustment to the allowance for doubtful accounts. Three financial factors and
five nonfinancial factors were varied at two levels. The results show that the auditors
materiality judgments were focused primarily on the effect of the item on net income. The
effect on earnings trend was found to be second in importance, although it explained much
less judgment variance. The results also showed that auditors used nonfinancial information
in their materiality judgments; however, the relative impact of nonfinancial cues was considerably less than the effect of net income. There was no agreement as to which specific
nonfinancial cues were important. Generally, there was no significant difference in measures
such as consensus, consistency, and number of cues used between partners and seniors in
their materiality judgments. However, the students measures on these criteria differed significantly from partners and seniors.
Estes and Reames (1988) studied the effect of personal characteristics (experience,
education, place of employment, frequency of materiality decisions, gender, and age) on
auditors materiality judgments and their confidence in those judgments. Five hundred
ninety-six CPAs responded to a survey that requested materiality decisions on two scenarios:
(1) the probability of the uncollectibility of a large account receivable from a single customer and (2) the amount of obsolete inventory that would cause auditors to qualify their
opinion in a situation where there is disagreement with management concerning the adjustment. Only age and place of employment significantly affected the participants materiality judgments. Employment in public accounting appeared to raise the threshold for
acceptance of likelihood of the collectibility of the large receivable (i.e., persons in public
accounting would accept 8 percent higher probability before qualifying audit opinion). Place
of employment was not significant for the inventory decision. Older CPAs appeared to be
more conservative with respect to qualifying an audit opinion for obsolete inventory.
Wong-On-Wing et al. (1989) examined how auditors perceptions of management affected audit decisions and judgments, including materiality threshold judgments. One hundred seventeen auditors were asked to indicate the importance of disclosing a gain on sale
of long-term assets and the amount of gain they considered material (as a percentage of
income before taxes) for their disclosure decision. The results indicate that lower materiality
thresholds were significantly associated with more dispositional inferences about management and that participants who inferred a disposition of management (i.e., perception of
management attributes) made more homogenous materiality judgments than those that did
not. Lower materiality thresholds were also associated with a higher perceived importance
of disclosure.
Carpenter and Dirsmith (1992) examined hypothesized relationships between materiality judgments and the size and nature of early debt extinguishment transactions, client
16
In a recent working paper, Libby et al. (2005) show that auditors have lower materiality levels for correcting
misstatements that are recognized in the financial statements compared to similar disclosures in the footnotes.
178
earnings trend, and experience of the auditor. They also examined whether auditor materiality judgments were affected by other contextual factors such as management motivation.
Two hundred twelve participants (partners, managers, and seniors) were randomly assigned
to 12 hypothetical cases. The participants were asked to indicate how material the gain
from the transaction was for each case. The results showed that the absolute dollar amount
of the early debt extinguishment transaction, the size of the transaction relative to net
income and total assets, as well as their interaction effects, influenced the auditors materiality judgments. The size of item, particularly relative to net income, was an important
variable. Participants also considered transactions that reversed downward earnings trends
to be more material than the transactions that did not. The nature of the transaction (i.e.,
in-substance defeasance encouraged auditors to exhibit stricter materiality standards than
ordinary debt extinguishment and bond refunding) was significant in the formation of the
auditors materiality judgment. Experienced auditors or auditors with task-specific knowledge scrutinized materiality judgments relating to discretionary, nonroutine transactions
more closely. Last, the results suggested that the use of qualitative contextual information
augmented the quantitative assessment of materiality.
In a related study, Carpenter et al. (1994) focused on understanding how auditors form
specific types of materiality judgments as a social process influenced by their firms culture.
The study involved 212 partners, managers, and seniors from Big 8 firms making materiality
judgments for hypothetical cases in relation to gains arising from debt extinguishment
transactions. The results suggest that audit firm culture (organic, intermediate, mechanistic)
and experience (partner, manager, senior) influenced the materiality judgment process.
Whittington and Margheim (1993) investigated the effect of inherent risk and materiality on external auditors reliance on internal auditors. Forty-two audit managers received
a case containing information on a hypothetical companys internal auditors and accounts
receivable data. Materiality was manipulated at low and high levels based on the amount
of the accounts receivable. The participants were asked to complete an audit time allocation
sheet indicating the amount of time assigned to the internal and external audit staff. The
results suggest that at the low materiality level the audit managers assigned more tests of
control work to the internal auditors.
Bernardi and Arnold (1994) examined the influence of four qualitative factors (perceived client level of integrity and competence, level of moral judgment, firm, and experience) on auditors materiality estimates. One hundred fifty-two managers and 342 seniors
from five Big 6 firms were presented with a case study and asked to indicate the smallest
size of an error in the inventory account that they considered to be material. Eighty-seven
percent of the participants estimated materiality at or above the lower end of the anticipated
range. The low integrity and competence groups estimates were not significantly different
than the high integrity and competence groups estimates. There were significant differences
across staff levels within individual firms. The variance of seniors estimates was higher
than the managers estimates, suggesting that increased experience produced more consensus. Last, the auditors level of moral judgment was significant for managersthere was a
reduction in their materiality estimate with an increase in Defining Issues Test scores.
Bernardi and Pincus (1996) examined how auditors quantitative materiality judgments
compared to ten common rules of thumb used for establishing materiality. In addition, the
relationship of prior expectation of risk of fraud, the amount of evidence examined, and
post-audit judgment of the risk of fraud were also investigated. One hundred fifty-two audit
managers evaluated materiality and risk for an actual case (a restaurant) where material
inventory fraud was undetected. The materiality decision required the participants to specify
the size of a misstatement in the clients inventory from nine categories ranging from a
179
low of less than $50,000 to a high of more than $400,000 with each intervening
category covering a $50,000 materiality range. All rules of thumb fell within the four middle
categories. The results indicate that a majority of auditors (75 percent) set their materiality
judgments within the rules of thumb identified by prior audit research. Auditors prior fraud
expectations were not related to their materiality judgments and the amount of evidence
examined or post-audit risk of fraud did not lead to significant differences in materiality
judgments.
Arnold et al. (2001) examined the effect of client integrity ratings, culture (Hofstedes
(1980) uncertainty avoidance scores by country), and the level of litigiousness (Windgates
[1997] litigation index by country) on materiality estimates from an international perspective. The sample included 181 auditors (25 partners, 67 senior managers, and 89 managers)
from Big 6 auditing firms from Denmark, Ireland, Italy, The Netherlands, Spain, Sweden,
and the United Kingdom. The audit scenario provided to the participants was the same as
the one used in Bernardi and Arnold (1994) and Bernardi and Pincus (1996). The auditors
were asked to estimate the size of error in the inventory account. The overall mean materiality for the seven European countries was significantly higher for the high-integrity group
than for the low-integrity group ($408,200 versus $323,500). Hofstedes uncertainty avoidance factor was also significant. The average materiality estimate increased with an increase
in uncertainty avoidance. The litigation variable was also significant, but contrary to expectations, the materiality estimate increased with an increase in the level of litigiousness.
Libby and Kinney (2000) complement archival research on earnings management by
examining auditors judgments of a detected misstatement that is quantitatively immaterial
to earnings.17 They conducted two experiments that manipulated the consensus EPS forecast
and auditing standards (pre SAS No. 89 or the proposed SAS No. 89). In experiment 1,
the auditor believed that managements allowance for inventory obsolescence was understated, resulting in overstated pre-audit earnings. Experiment 2 was identical to experiment
1 except that the inventory overstatement was objectively determined (i.e., it related to
inadvertent duplication of counts of the inventory on hand). The size and magnitude of the
misstatement ($0.03 per share) that is immaterial by conventional materiality guidelines
was held constant across all experimental conditions. Audit managers from various offices
of a Big 5 firm made judgments about likely magnitudes of reported EPS. Their results
suggest that auditors expect a majority of clients to make full correction of quantitatively
immaterial misstatements only if forecast EPS will not be missed. The results also indicate
that SAS No. 89 is likely to increase the number of immaterial corrections of misstatements,
but only when the correction does not cause earnings to fall below the forecast.
Braun (2001) examined the impact of reward and risk factors on auditors propensity
to waive proposed adjusting journal entries (PAJEs) that exceed materiality in client-auditor
conflict situations. The factors manipulated included the clients relative fees as a share of
office fees, the clients financial health, the subjectivity of PAJEs, and the PAJEs aggregate
effect on income. One hundred fifty-five audit partners and managers from ten offices of a
Big 6 firm participated. The participants completed eight independent cases by recording
their decision to waive or insist that the client book the PAJE. Materiality was specified at
$1 million. The dollar value of each PAJE varied only slightly across cases with immaterial
PAJEs ranging from $625,000 to $650,000 and material PAJEs from $1,235,000 to
17
The Libby and Kinneys (2000) study of SAS No. 89 shows the effect of private regulation of auditors by
auditors, whereas SAB No. 99 and SOX applies public regulation to both managers and auditors. Thus, Libby
and Kinney (2000) were working with the limitation of audit regulation as opposed to financial reporting
regulation.
180
$1,265,000. The results indicate that the three risk factors were significant in the auditors
judgments while the reward factor (relative fees) was not significant. The results also indicate that auditors are more willing to waive PAJEs in excess of materiality when PAJEs
increase, rather than decrease, income in aggregate. Last, a higher percentage of participants
were willing to make non-GAAS decisions when the PAJEs were individually immaterial
but material in aggregate, than when the PAJE was a single material amount.
Ng and Tan (2003), using the same instrument as Kinney and Libby, conducted an
experiment in which auditors made a judgment about a proposed audit adjustment (the
difference between the client and proposed auditor revenue recognition method) that was
quantitatively immaterial but if fully booked, would cause the companys adjusted EPS to
fall short of the analysts consensus forecast by one cent per share (i.e., a qualitative materiality factor). The availability of precise authoritative guidance (absent versus present)
and audit committee effectiveness (low versus high) were manipulated. One hundred thirteen audit managers from various U.S. offices of Big 4 firms completed the task via the
Internet. Results show that auditors perceived negotiation outcome is jointly influenced by
authoritative guidance availability and audit committee effectiveness. On average, auditors
rated the materiality of the auditor adjustment to be moderate; suggesting that they do
consider analysts forecast in their materiality assessments. Auditors materiality and engagement risk assessments did not vary systematically across experimental conditions.
Nelson et al. (2005) examined whether two quantitative materiality approaches (cumulative or current-period) used in practice affected auditors decisions to book adjustments.
Under the cumulative approach, only misstatements detected in the current period are evaluated while the current-period approach considers not only the misstatements detected in
the current period, but also the rollover effect of misstatements not booked in the prior
period. Two hundred thirty-four partners and managers responded to eight cases that manipulated qualitative and quantitative misstatement characteristics that prior research indicated may affect materiality judgments and adjustment decisions. Nelson et al. (2005) report
that, across a variety of factors (e.g., misstatement size, subjectivity of the misstatement,
precision, and income effect), auditors are more likely to require the client to book the
misstatement under the materiality approach that makes the misstatement appear more material. They recommend that standard setters mandate auditors to adjust any misstatement
that is material under either approach.
Comparative Studies
Jennings et al. (1987) conducted an experiment to assess the consistency with which
practicing auditors operationally define materiality as compared to judges/lawyers. Five
financial disclosure cases were used (write-off of obsolete inventory, a gain on the sale of
property, a lawsuit, a bribe, and discontinued product line) and participants were asked to
determine the dollar threshold at which the misstatement or nondisclosure of an item would
become material. The findings show significantly different views of materiality existed
across cases and there was high variation between the groups in determining materiality.
In a related study, Jennings et al. (1991) investigated auditors and judges/lawyers
attitudes toward materiality and disclosure judgments. They found that the attitudes of
judges/lawyers differed substantially from auditors, with the judges/lawyers exhibiting
higher standards of disclosure. Additionally, the judges/lawyers expressed a high level of
agreement for explicit quantitative standards for materiality.
181
Summary
The experimental research studies have produced a number of important findings. First,
consistent with the other types of research, net income continues to be the most important
factor in determining the materiality of a misstatement. A number of studies also find that
the effect of the misstatement on earnings trend is of secondary importance. Second, a
number of qualitative factors were tested and found to affect materiality decisions. Third,
materiality judgments vary by experience and firm type. Finally, authoritative guidance can
have an effect on auditors materiality judgments.
SUMMARY AND AREAS FOR FUTURE RESEARCH
Since 1982 there has been a substantial body of materiality research. Some of the issues
cited by Holstrum and Messier (1982) continue to be relevant. Additionally, a number of
more contemporary materiality topics have been the subject of research and other issues
are in need of examination.
Establishing Planning Materiality
The review of the major firms (e.g., Big 8 and then Big 6) audit manuals has provided
important information on the variability of the firms approaches to materiality. One area
of variability is establishing planning materiality. While the majority of firms use a percentage of income (e.g., 5 percent) to establish planning materiality, other firms use assets
and/or revenues to determine planning materiality. Variability also exists in the allocation
of planning materiality (or determination of tolerable misstatement) to financial statement
accounts or assertions. Some firms use mechanical methods (e.g., a percentage such as 50
percent of planning materiality) to allocate while other firms do not allocate planning materiality. The results of such differences in materiality methods can affect both the effectiveness and efficiency of audits. For example, if firms differ in how they allocate materiality
to financial statement accounts, then the scope of the work could differ across audits with
similar characteristics.
With the recent issuance of the ASB and IAASB exposure drafts on materiality (AICPA
2005a; IAASB 2004), future research could follow a couple of approaches. Since the last
study of firms audit manuals, the Big 6 have become the Big 4. Additionally, most of the
major firms have revised their audit methodologies to take a broader view of business and
audit risks (AICPA 2005a; Bell et al. 1997). Future research could examine the Big 4 plus
the other major firms audit manuals in order to update the degree of variability between
firms in their guidance on materiality. While it is unlikely that one method for determining
planning materiality is optimal, future research could investigate the effects of this variability and its effect on users of the financial statements. Last, future research could investigate alternative methods for allocating planning materiality to financial statement accounts
or assertions (see comments below on multilocation audits) (Braun and Dutta 1998).
Evaluation Materiality Decisions
An equally important area is the evaluation of the materiality of detected misstatements
(evaluation materiality). Research since 1982 sheds light on this issue. First, the research
studies that examined auditors work papers showed that the decision to book or waive
detected misstatements entails multiple factors in addition to the size of the misstatement
(i.e., its effect on income). Prior research finds that nature of the misstatement and size of
the client can affect the auditors decisions to waive adjustments. For example, misstatements that are objectively determined as opposed to subjectively determined are more likely
to be booked (Wright and Wright 1997). Similarly, as the size of the client increases,
182
misstatements are more likely to be waived. Last, the recent study by Libby et al. (2005)
shows that materiality levels vary depending on whether a misstatement will recognized in
the financial statements or disclosed in the footnotes.
Elder and Allen (1998; Allen and Elder 2005) presented some interesting findings on
auditors reluctance to project detected misstatements. When an auditor performs an audit
procedure that involves sampling (either statistical or nonstatistical), detected misstatements
should be projected to the population in order to determine the materiality of the possible
misstatements (AU 350.26). Auditors apparently decide to project based on the materiality
of the detected misstatement.
Recent behavioral research by Libby and Kinney (2000) and Ng and Tan (2003) showed
that the decision to waive an adjustment can be affected by whether booking the misstatement will cause the client to miss analysts forecasted earnings (a qualitative factor). These
studies also show that the decision to waive a detected misstatement is affected by specific
professional guidance and an effective audit committee. With the recent change in the
regulatory environment for managers and auditors brought on by the Sarbanes-Oxley Act
(U.S. House of Representatives 2002), these issues may require additional research.
An area where practitioners disagree, and one that is in need of research, is how to
handle the effect of waived adjustments from the prior year in evaluating materiality during
the current year audit. In practice, two methods are used. Recent work by Nelson et al.
(2005) suggests that, depending on the type and direction of the misstatements, neither
approach provides a satisfactory answer to evaluating materiality. This is an area where
standard setters can play a more active role.
Future research should continue to look at the effect of qualitative factors on auditors
decisions to book or waive detected misstatements. More research is also needed to study
auditors decisions to project misstatements to the population. This is particularly important
given the decline in the use of statistical sampling where specialists would be used to assist
the audit team.
Nature of the Items Examined
Holstrum and Messier (1982) noted that variability of the nature of the items tested
made it difficult to integrate the results of materiality studies. The nature of the item examined continues to be an issue in materiality research. For example, the studies that relied
on public sources of information (e.g., published financial statements) examined capitalization of interest costs, inflation accounting disclosure, foreign currency translation, contingency disclosure, LIFO disclosure, accounting for income taxes, equity-for-debt swaps,
and cost of postretirement benefits other than pensions. Similar problems arise when one
looks at the various issues tested in behavioral experiments on materiality.
The Materiality of Internal Control Deficiencies
Mayper (1982) and Mayper et al. (1989) are the only studies that examined how auditors judge the materiality of internal accounting control weaknesses (IACWs). These
studies find that there are individual differences in the choice and importance of factors
used by auditors to rank materiality of IACWs and to determine materiality thresholds. For
example, the models of auditors judgments showed that the type of IACW, type of asset,
and likely dollar effect varied in importance, and also showed that both qualitative and
quantitative factors were considered by the auditors. Their results suggest that auditors may
need more structured criteria to make IACW materiality judgments for public disclosure
and to meet other legal requirements.
183
These findings are particularly important now that the Sarbanes-Oxley Act of 2002
requires internal control reporting by listed companies. The PCAOBs Auditing Standard
(AS) No. 2 requires that the auditor identify significant accounts. The same conceptual
approach to materiality that applies to a financial statement audit (i.e., establish planning
materiality and allocate materiality to accounts) applies to identifying significant accounts,
and includes both quantitative and qualitative considerations. The factors the auditor should
evaluate when identifying significant accounts for an audit of internal control over financial
reporting include: nature, size, and composition of the account; susceptibility of loss due
to errors or fraud; volume, complexity, and homogeneity of the individual transactions
processed through the account; likelihood of significant contingent liabilities arising from
the activities represented by the account; existence of related-party transactions in the account; and changes from the prior period in account characteristics (AS No. 2, 65).
An account is defined as significant if there is more than a remote likelihood that the
account could contain misstatements that individually, or when aggregated with others,
might have a material effect on the financial statements (AS No. 2, 61). Other accounts
may be significant on a qualitative basis with reference to the expectations of a reasonable
user.
Future research can compare AS No. 2 guidance across firms for how significant accounts are determined. Audit working papers can also be examined the consistency of
application of the firms guidance. Last, where the firm guidance is not specific, behavioral
studies can be conducted to observe the factors that affect the auditors judgments.
AS No. 2 lists three levels of internal control exceptions: control deficiency, significant
deficiency, and material weakness. The guidance developed by the profession (A Framework
for Evaluating Control Exceptions and Deficiencies, AICPA 2004b) makes it very clear that
there is substantial judgment involved in determining the proper classification of control
deficiencies.18 Future research should test the application of this materiality guidance for
determining whether a control deficiency is a significant deficiency or a material weakness
using data from working papers. Since this guidance involves substantial judgment, behavioral studies can shed light on which factors are important in determining the classification
of control deficiencies.
Multilocation Audits
No research that we are aware of has investigated how planning materiality (or its
allocation) or evaluation materiality is handled on multilocation audits. Given the diverse
nature of, and/or multinational operations of, enterprises today, research in this area is
needed. Additionally, the evaluation of the materiality of internal control deficiencies across
multilocation audits also needs to be researched.
Materiality in Attest Engagements
Virtually all of the research on materiality has dealt with traditional financial statement
auditing. In recent years, there has been significant growth in providing assurance on other
types of information. For example, in the U.S., attestation standards cover various subject
matters (e.g., internal control, and management discussion and analysis). The IAASB recently passed its framework for assurance engagements.19 One potential engagement that
18
19
The importance of this decision affects reporting by both management and the auditor. Generally, a significant
deficiency would not prevent management from asserting that internal control is effective and the auditor from
issuing an unqualified opinion. However, the presence of a material weakness precludes management from
asserting that internal control is effective. It also requires the auditor to issue an adverse opinion.
The IAASBs assurance engagements are comparable to U.S. attestation engagements.
184
has been proposed for the IAASBs new framework is sustainability (environmental) reporting. Research is needed to determine what is material and how is it determined when
the subject matter of the auditors report is something other than financial data.
CONCLUDING COMMENTS
This paper had two objectives: to review and integrate the empirical research on materiality since 1982, and to identify the implications of this research for audit practice and
suggest areas for future research. Our review indicates that there has been substantial research on materiality since the Holstrum and Messier (1982) review. Much of this research
has contributed to our understanding of materiality. However, many questions still remain.
We have identified a number of areas where future research should proceed. It is our hope
that audit researchers will begin to investigate these important problems.
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A Review and Integration of Empirical Research On Materiality: Two Decades Later

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AUDITING: A JOURNAL OF PRACTICE & THEORY

Vol. 24, No. 2

A Review and Integration of

Submitted: January 2005

Messier, Martinov-Bennie, and Eilifsen

Auditing: A Journal of Practice & Theory, November 2005

A Review and Integration of Empirical Research on Materiality: Two Decades Later

Messier, Martinov-Bennie, and Eilifsen

Materiality and the Audit Process

Auditing: A Journal of Practice & Theory, November 2005

A Review and Integration of Empirical Research on Materiality: Two Decades Later

Auditing: A Journal of Practice & Theory, November 2005

Messier, Martinov-Bennie, and Eilifsen

Auditing: A Journal of Practice & Theory, November 2005

Panel A: Studies Based on Information from Audit Manuals

Audit manuals obtained from six of

Guidelines in audit manuals about

The planning-stage materiality judgments

Analysis of audit manuals, other

Analysis of how materiality

Auditing: A Journal of Practice & Theory, November 2005

Audit manuals of ten U.S. audit

A Review and Integration of Empirical Research on Materiality: Two Decades Later

Auditing: A Journal of Practice & Theory, November 2005

Panel B: Studies Based on Information from Audit Working Papers

The study attempts to identify

1,424 detected misstatements in 147

Materiality judgments as reflected

235 sampling applications for 64

Auditors decision to quantify

Elder and Allen

Examine variables that may explain

The effect of the misstatements on net

income was significant in their decisions, but

Materiality (misstatement amount relative to

planning materiality) appeared to be an

Messier, Martinov-Bennie, and Eilifsen

Panel B: Studies Based on Information from Audit Working Papers, continued

Compare these results to the error

Planning materiality judgments from

Investigate the planning materiality

Immateriality continued to be a main reason

There were significant changes in the extent

to which individual firms used materiality as

Auditing: A Journal of Practice & Theory, November 2005

200 sampling applications for 53

A Review and Integration of Empirical Research on Materiality: Two Decades Later

Messier, Martinov-Bennie, and Eilifsen

Auditing: A Journal of Practice & Theory, November 2005

A Review and Integration of Empirical Research on Materiality: Two Decades Later

Auditing: A Journal of Practice & Theory, November 2005

Auditing: A Journal of Practice & Theory, November 2005

Audit reports and financial statement

Differences in absolute and relative

For the absolute dollar amounts of interest

Annual reports for 201 large U.S.

The relationship between publicly

Banks that did not report current cost

information did so on the basis of the

Messier, Martinov-Bennie, and Eilifsen

Audit reports and financial statement

capitalized, the mean was smaller and

Audit opinions and financial