The Materiality Judgment Gap: An experimental study

Abstract:    The Securities and Exchange Commission (SEC) has expressed concern that auditors’ use of materiality allows misstatements to go uncorrected. Auditors do not require their client to correct the financial statements for immaterial misstatements. According to the professional standards, an immaterial misstatement is defined as one that has no effect on average user’s decisions. However, little is known about users’ materiality perceptions and what is considered to be material from user’s point of view. This study investigates auditors’ and users’ materiality decisions by conducting three experimental cases to examine auditors’ and users’ assessments of materiality. Since materiality choices are not disclosed in the auditors’ report or elsewhere, users of financial statements have no information as to the precision of the balances shown. Several regulations have proposed that auditor should be required to disclose his materiality threshold to users. To date, this proposal has not been enforced. This study also investigates the extent to which users of the financial statements find the disclosure of auditor materiality threshold useful. The results suggest that significantly different views of materiality exist across different cases. Understandably, users demonstrate lower materiality threshold than auditors. Materiality judgment gap does exist between auditors and users of financial statements. The results also suggest that there is a strong agreement among users with auditor materiality disclosure as a possible way to alleviate the impact of the materiality judgment gap as it facilitates users’ perceptions of the accuracy of the auditor’s report, and reduces overconfidence behavior in investment decision.