A NEW LOOK AT MATERIALITY
What are the latest views on materiality in financial accounting? How have standards for measuring materiality changed since passage of the Sarbanes-Oxley Act? And what new approaches are being taken to better assess the materiality of financial information? In the aftermath of the Enron scandal, corporate financial statements are under greater scrutiny than ever, forcing auditors to pay closer attention to many transactions previously considered immaterial. This paper reviews the basis of materiality in financial reporting and the methods commonly used to assess what is – and what is not – material.
The concept of materiality has been receiving increased scrutiny by the Securities and Exchange Commission since at least 1998, when then-chairman Arthur Levitt made his much-quoted “Numbers Game” speech. Levitt complained of the misuse of materiality by companies that deliberately record misleading financial information to increase their earnings statements, and then later claim that any errors introduced were immaterial. Levitt clearly abhorred the practice and went on to say that “in markets where missing an earnings projection 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 don’t matter” (Messier, et al, 2005, p. 154). In the year following Levitt’s speech, the SEC issued Staff Accounting Bulletin No. 99, which made it clear that quantitative measures alone are insufficient to determine materiality; qualitative measures must be considered, too. For example, if the inclusion of any item or transaction, however small, will cause a firm to miss forecasted earnings estimates, then that item must be properly recorded and reported.
The abuse of materiality standards can be traced back to the mid-1980s, when Wall Street intensified its focus on quarterly earnings and practically demanded continual increases in...
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