Discrepancies Between Financial Statement Users’ Materiality and Audit Materiality: Can Public Disclosure Close the Gap?

• In Event: Disclosures

Abstract

We investigate whether there is a “materiality gap” between the materiality judgments of non-professional investors (a set of “reasonable users” identified in standard definitions of materiality) and the materiality limits set by accounting practitioners, and if so, whether public disclosure of audit materiality will reduce the gap. To address the research questions, we use a 3×2 experiment manipulating public materiality disclosure (disclosure of a high or low materiality number or no disclosure) and the good or bad news nature of a subsequent event. We find evidence of a user-practitioner materiality gap in both the magnitude and symmetry of materiality judgments. Absent a materiality disclosure, non-professional investors report lower materiality thresholds than auditors, and they exhibit lower materiality levels for bad news events relative to good news events both in their stated preferences and investment decisions. In contrast, practitioners calculate a single, higher number for materiality without regard to the nature of financial information as good or bad news. In both disclosure conditions, we find that materiality disclosure reduces the distance between user and auditor materiality thresholds and eliminates the asymmetry in investors’ stated materiality levels. However, disclosure fails to attenuate the asymmetry in investors’ exhibited materiality levels as indicated by their investment decisions in response to good and bad news events.

Authors

• Marcus M. Doxey, University of Alabama-Tuscaloosa

• Richard Hatfield, University of Alabama-Tuscaloosa

• Richard Kyle Peel, University of Alabama-Tuscaloosa

• Jordan Alleyne Rippy, University of Alabama-Tuscaloosa