AUDITORS’ RECOGNITION AND DISCLOSURE MATERIALITY THRESHOLDS: THEIR MAGNITUDE AND THE EFFECTS OF INDUSTRY

Materiality thresholds are the dividing line between material and immaterial information. Recognition materiality thresholds are the dividing line between what is recorded and what is not recorded in the accounts. Disclosure materiality thresholds are the dividing line between what is separately disclosed in the financial statements and what is not separately disclosed. Auditors materiality thresholds are important because they have a significant influence on what information is recorded in the accounts and disclosed in financial statements and hence available for decision making by external parties. However, there are no research findings about recognition thresholds, and those in relation to disclosure thresholds show a lack of consensus. Hence the motivation for this research. The objective of the research is to study auditors’ recognition and disclosure thresholds within the context of industry, which is divided into the industry of the firm and the industry specialization (experience) of the auditor. The results of the study show that: (1) Recognition thresholds are significantly lower than disclosure thresholds. (2) The mean thresholds are 5·7% (recognition) and 8·7% (disclosure). These are in the 5% to 10% guideline provided by Australian accounting standards. (3) The thresholds appear to vary with industry market risk. (4) Auditors appear to use the thresholds from the industry in which they specialize, in an industry in which they do not specialize. The paper discusses the implications of these findings.     

Consensus views and judgment models in materiality decisions

The paper reports the results of a recent experimental study into the materiality-disclosure problem. Thirty case situations involving losses and gains on the sale of business assets were presented to 150 individuals and they were asked to state whether they would call for separate disclosure of the losses/gains as extraordinary items in the annual financial statements. Significant differences in the responses of the individuals were found and the results indicated that some consideration should be given by the professional accounting bodies to giving more guidance on materiality — disclosure decisions.     

An inconsistency in SEC disclosure requirements? The case of the “insignificant” private target

Although the SEC's main charge is to ensure the disclosure of material information, it has not always consistently defined materiality. We show that acquisitions of privately-held targets classified as “insignificant” by the SEC appreciably affect market prices, and therefore are material by the SEC's definition. We find significant returns in transactions with targets as small as 2% – compared with the SEC's disclosure threshold of 20% – of the acquirer. Further, an average of 19 undisclosed private acquisitions per year exceed the median IPO value in the same year for our sample period. However, because the SEC deems these transactions insignificant, information like target financial statements remains undisclosed to the market. Disclosure rules regarding target financial statements thus create a regulatory disconnect, in which information that is material is nevertheless deemed “insignificant” and therefore not disclosed.     

Disclosure of contingent legal liabilities

There has long been user dissatisfaction with firm’s disclosure of contingent legal liabilities, and the FASB, IASB, and SEC have all considered compliance issues and standard amendments on this topic in recent years. This study uses a sample of employment discrimination cases to provide evidence on the extent to which current contingent legal liability disclosures provide useful contingency evaluations. Consistent with legal concerns influencing reporting decisions, I find that current disclosure practices provide limited quantitative detail regarding the magnitude of the expected loss. However, the text of the disclosures does provide qualitative indicators of the probability of loss. I find evidence that statements about the inestimable nature of the loss and statements about the firm’s willingness to consider a settlement are related to higher probabilities of loss and higher loss amounts. I also find evidence that statements regarding an existing accrual for losses and warnings about materiality reflect a higher likelihood of a nontrivial loss. These results emphasize firms’ strong resistance to quantitative disclosures of legal contingencies but suggest that existing SFAS 5 disclosures do contain qualitative information useful for evaluating the loss contingency.     

重要性判断与会计信息披露——来自隐晦重述的证据

重要性是会计中的基础问题,是证券市场信息披露筛选过滤的门槛,重要性原则的不确定使得重要性概念极易被利用和操纵.然而,国内现有研究却鲜有关于重要性应用的经验证据.为此,本文以隐晦重述为研究对象,从财务报告披露环节的策略选择问题入手,揭示重要性判断在实务中的具体应用.研究发现:重要性门槛的不确定给公司战略性披露信息提供了机会,重述越重要,公司越倾向于隐晦披露,好的公司治理有助于改善重要性程度对隐晦重述的影响,提高信息披露的透明度.     

Materiality Judgments and Disclosure of Retiree Health Care Costs Under SFAS No. 81

Generally, researchers have difficulty empirically examining materiality judgments because amounts designated as immaterial are not disclosed. However, reporting requirements under SFAS No. 106 provide a unique opportunity to evaluate expense amounts designated immaterial under SFAS No. 81. We use the cumulative effect associated with the adoption of SFAS No. 106 to evaluate prior management materiality judgments. Univariate and logistic regression results suggest that the decision to disclose SFAS No. 81 costs is positively related to our measures of plan materiality. However, our results also suggest that voluntary disclosure factors may have influenced the disclosure decision.     

Corporate Lobbying Behaviour on Accounting for Stock-Based Compensation: Venue and Format Choices

This article investigates U.S. corporate lobbying of the Financial Accounting Standards Board (FASB) in the U.S. on the exposure draft to Financial Accounting Standard No. 123 (FAS 123), Accounting for Stock-Based Compensation . Essentially, firms lobbied the FASB in one of three ways: (a) against disclosure/recognition of any additional information beyond that already required in U.S. proxy statements, (b) for summary footnote disclosure of all employee stock-based compensation (SBC), or (c) for either pro forma or formal income statement recognition of all employee SBC.
This study finds that the higher the level of the SBC of the top five executives, the less likely firms are to favour disclosing that information. This finding supports the hypothesis that economic self-interests motivated lobbying behaviour on FAS 123. Furthermore, the study finds that U.S. corporations lobby against disclosure of executive SBC in the annual reports even when the annual reports would disclose no additional information beyond that currently disclosed in proxy statements. This is evidence that managers perceive that the venue of disclosure (proxy versus annual report) matters. It is posited that managers lobbied against disclosure of SBC to avoid possible changes to compensation contracts which in turn could adversely affect stock prices. In sum, the results support the notion that managerial self-interest affects lobbying behaviour on the venue as well as the format of disclosure.     

Impact of earnings performance on price‐sensitive disclosures under the Australian continuous disclosure regime

This study examines the relation between accounting earnings and the frequency of price‐sensitive corporate disclosure under Australia's statutory continuous disclosure requirements. Despite low litigation threats and excepting loss‐making firms, results show that firms with earnings declines (bad news) are more likely to make continuous disclosure than firms with earnings increases (good news). This suggests that market forces and regulators’ scrutiny are sufficient to induce a ‘bad news’ disclosure bias. This study also examines the ‘materiality’ requirement under the continuous disclosure requirements and finds a positive relation between disclosure frequency and the magnitude of earnings news. The earnings–return correlation is positively associated with disclosure frequency for the financial services industry.     

Voluntary Disclosure of Information in a Setting in which Endowment of Information has Productive Value

Abstract:  This paper introduces a model capturing managers' disclosure policies in settings in which disclosure is rewarded by the financial market because disclosure implies that managers are endowed with information and endowment of information may potentially improve the firm's productive efficiency. It provides sufficient condition for a threshold disclosure equilibrium to obtain and compares disclosure policies in a setting in which endowment of information improves the firm's productive efficiency with disclosure policies in a setting in which endowment of information has no impact on the firm's productive efficiency. Managers' disclosure policies are shown to depend crucially on whether the endowment of information is exogenous or endogenous. When the endowment of information is exogenous, an increase in the usefulness of information in improving the firm's productive efficiency leads to a decrease in the disclosure threshold and hence an increase in the amount of information disclosed. In contrast, when the endowment of information is endogenous, an increase in the usefulness of information in improving the firm's productive efficiency has no effect on the disclosure threshold but leads to a decrease in the probability with which information is acquired and hence a decrease in the amount of information disclosed. As, in the threshold disclosure equilibrium, the net present value of information acquisition arising from any increase in production efficiency is negative, an increase in the usefulness of information in improving the firm's productive efficiency thus reduces the inefficiency caused by information acquisition.     

Qualitative audit materiality and earnings management

This study investigates auditors’ propensity to rely on quantitative materiality thresholds to the exclusion of qualitative materiality thresholds. Specifically, we examine whether auditors are more likely to allow earnings management that is less than typical quantitative materiality thresholds but that nonetheless is qualitatively material. We use changes in tax expense as a proxy for earnings management. Our results indicate that companies with pre-managed earnings that would have missed the consensus analyst forecast are more likely to decrease their tax expense when the magnitude of the decrease is less than quantitative audit materiality thresholds. The results also indicate that firms are more likely to meet or beat the forecast when the amount of earnings management necessary to meet the analyst forecast is less than quantitative materiality. These results are consistent with auditors relying on quantitative materiality thresholds to the exclusion of qualitative materiality thresholds, i.e., the importance of meeting or beating the analyst forecast. Finally, we find that the ability to use tax expense reduction within quantitative materiality to meet or beat analysts’ consensus forecasts was significantly reduced by the SEC’s guidance on materiality in SAB-99 and by the passage of the Sarbanes–Oxley Act.     

An investigation of nonprofessional investors’ qualitative materiality judgments incorporating SEC listed vs. non-listed events

When the SEC began listing specific potentially material events in its Regulation FD [Regulation Fair Disclosure, 2000. SEC Release 33-7881, Rules 101–103], it deviated from its long-time “policy” of not providing materiality guidance to auditors and managers. What is currently unclear in the materiality literature is which factor(s) – information-based characteristics or user-based characteristics – has an effect on nonprofessional investor qualitative materiality judgments. Using a series of experimental markets, we examine and find no evidence that an information-based characteristic (distinguishing between listed and non-listed events) has an effect on nonprofessional investors’ materiality judgments. Our evidence regarding user-based characteristics is mixed. We do not find evidence of the direction of disclosed events impacting investors’ judgments, but we do find evidence of an anchoring effect. Our findings indicate that the content of the information disclosed to nonprofessional investors is not as important as the timing of the disclosure. Our investigation is unique in that we consider the (qualitative) nature of the event, rather than simply its (quantitative) magnitude.     

The Disciplinary Role of Financial Statements: Evidence from Mergers and Acquisitions of Privately Held Targets

This study examines whether requiring the disclosure of audited financial statements disciplines managers’ mergers and acquisitions (M&As) decisions. When an M&A transaction meets certain disclosure thresholds, the Securities and Exchange Commission (SEC) requires the public acquirer to disclose the target's audited financial statements after the merger is completed. Using hand‐collected data, I find that the disclosure of private targets’ financial statements is associated with better acquisition decisions. Furthermore, I find that this disciplining effect of disclosure is more pronounced when monitoring by outside capital providers is more difficult and costly, and when other disciplining mechanisms are weaker. Finally, these findings are robust to several alternative explanations, such as monitoring from blockholders and voluntary disclosures. In sum, the evidence suggests that the ex post mandatory disclosure of private targets’ accounting information disciplines managers’ acquisition decisions and improves acquisition efficiency.     

Information dissemination on intellectual capital in mergers and acquisitions: purchase price allocations,press releases and business press

In order to reduce information asymmetries in relation to a firm's current decisions and long-term strategy, firms must consistently provide information to stakeholders. This paper investigates intellectual capital (IC) information disclosed in mergers and acquisitions (M&A) provided through three different disclosure channels (voluntary press releases, related newspaper articles and subsequent mandatory corporate disclosures in the notes to the financial statements). For a sample of 215 randomly selected US and European M&As, we analyse 215 press releases, 1025 newspaper articles and 215 purchase price allocations. Our findings suggest that IC disclosure in press releases is not perceived as informative and qualitative forward-looking IC information in voluntary corporate disclosures appears to lack credibility. Moreover, we empirically demonstrate interdependencies across the three disclosure channels. The business press seems to filter IC information provided in press releases. The amount of IC disclosure in the notes to the financial statements is positively associated with prior IC disclosure in newspaper articles, but negatively associated with IC disclosure in press releases. The managements of acquirer firms appear to pay attention to news coverage and public opinion. However, both voluntary and mandatory corporate disclosures appear to substitute rather than complement each other.     

Discretionary compliance with mandatory environmental disclosures: Evidence from SEC filings

We examine the determinants of adherence to U.S. Securities and Exchange Commission (SEC) mandated disclosures of environmental sanctions. Our sample includes non-superfund U.S. Environmental Protection Agency (EPA) sanctions between 1996 and 2005. Our results suggest that firms are more likely to provide sanction disclosures if they operate in environmentally sensitive industries, are subject to larger penalties and are voluntarily participating in a supplemental environmental project. Our results also suggest that firms are less likely to disclose sanctions involving judicial proceedings. Overall, we find that voluntary disclosure incentives impact compliance with mandatory reporting requirements. Although incentives exist for firms to comply with mandatory disclosures, our results suggest that increases in mandatory environmental accounting disclosures may not be effective under the current regulatory system despite the use of bright-line materiality thresholds. Our study contributes to the current and ongoing debate about the role and effectiveness of environmental risk disclosure mandates in providing information to the marketplace, as well as “mandated disclosure” rules in general. The value attributed to current and potential environmental disclosure regulations cannot be thoroughly understood without examining disclosure compliance with existing regulations. From an environmental and sustainability disclosure perspective, our findings are particularly germane since these disclosures focus on risks, liabilities, or other reputational shortcomings of the firm.     

Do conventional financial disclosures matter in alternative financing? Evidence from equity crowdfunding

As a novel form of external financing, equity crowdfunding enables small and early stage firms to raise capital from the public through an online platform. There has been criticism of the benefits and costs of mandating financial statements to promote this alternative form of financing. Using a setting where disclosure of financial statements is optional, this study provides evidence that financial statements influence investors’ decisions and facilitate borderless capital formation. The provision of financial statements appears to enhance how investors view other aspects of disclosure, suggesting a positive reporting externality. These market-wide benefits provide important insights on the role of financial disclosures for market participants, policymakers, and academics.     

The Impact of Recognition Versus Disclosure on Financial Information: A Preparer's Perspective

We investigate whether recognition on the face of the financial statements versus disclosure in the footnotes influences the amount that financial managers report for a contingent liability. Using an experiment with corporate controllers and chief financial officers, we find that financial managers in public companies expend more cognitive effort and exhibit less strategic bias under recognition than disclosure. This difference appears to be associated with capital market pressures experienced by public company managers as we find that both the cognitive effort and bias exhibited by private company managers are unaffected by placement. As a result, public company managers make higher liability estimates for recognized versus disclosed liabilities. Their liability estimates are similar to those of private company managers for recognition but lower than private company managers’ estimates for disclosure. Our results have implications for auditors and financial statement users in evaluating recognized versus disclosed information for public and private companies.     

IFRS adoption and analysts’ earnings forecasts: Australian evidence

We study 145 large listed Australian firms to explore the impact of international financial reporting standards (IFRS) adoption on the properties of analysts’ forecasts and the role of firm disclosure about IFRS impact. We find that analyst forecast accuracy improves, and there is no significant change in dispersion in the adoption year, suggesting that analysts coped effectively with transition to IFRS. However, we do not observe the expected relationship between firms’ IFRS impact disclosures in their financial statements issued at the end of the transition year with forecast error and dispersion in the adoption year. The results question the timeliness and usefulness of financial statement disclosure, even in a setting where disclosure was mandated by accounting standards (AASB 1047 and AASB 1) and firms had strong incentives to provide information to analysts.     

Not‐for‐Profit Annual Reports: What do Museum Managers Communicate?

This study addresses: (1) What disclosures are provided in annual reports of not‐for‐profit entities?(2) What characteristics of the reporting entities explain variations in the quantity of financial disclosure?(3) How do not‐for‐profit disclosures compare with those in for‐profit corporate reports? The annual reports of 170 not‐for‐profit museums were examined. The reports were highly variable. Some contained no financial data and only 22 percent included complete financial statements with footnotes. Regression analysis indicated that the amount of museum financial data was positively associated with museum size, a larger number of pages of donor disclosures, and museum type (art and history, but not science, natural history, or general).