An inventory of materiality guidelines in accounting literature.by Worthington, James S.
The concept of materiality provides an excellent example. Authoritative accounting pronouncements provide few specific quantitative guidelines concerning materiality, therefore, determining materiality is largely a matter of judgment. Accountants continually face situations involving materiality judgments, not only in day-to-day accounting decisions but also in their role as independent auditors. This article summarizes the sources in which specific guidance is provided on the subject of materiality.
A search of authoritative pronouncements was made using the National Automated Accounting Research System (NAARS), an automated electronic database. The following pronouncements were considered: Accounting Research Bulletins (ARBs), Accounting Principles Board Opinions (APBs), AICPA Accounting Interpretations (AINs), Statements of Financial Accounting Standards (FASs), and FASB Interpretations (FINs). Specific quantitative guidelines and judgment items associated with those guidelines were identified and compared to the findings across the different pronouncements. The following terms and variations of such terms were used in the search of the pronouncements: material, substantial, significant, and percent. Once a pertinent source was located, a printed copy of the original pronouncement was examined and evaluated to determine whether a reference was applicable to this study. This analysis of the authoritative accounting pronouncements reveal that selected percentages are often provided as materiality guidelines. The alternative percentages provided in the accounting pronouncements are identified and summarized by judgment area.
In addition to percentages, authoritative pronouncements also provide selected guidance about "judgment items" which may be used as a basis for materiality judgments. These items are not themselves percentages for determining materiality, they both suggest certain comparisons.
in many materiality judgments, a comparison of an individual item to 1) income before extraordinary items, 2) net income, or 3) the trend of earnings, is suggested. Sometimes, judgment is required based simply on the nature of the event, such as an extraordinary item. In other situations the pronouncements leave the determination open-ended by suggesting that "other appropriate criteria should be considered." The alternative judgment items provided in the accounting pronouncements are identified and summarized by judgment area.
Based on an analysis several observations can be made. Only 10% of authoritative accounting pronouncements contain specific materiality percentages, and only 6% give judgment items. The percentage of pronouncements giving these guidelines has changed little since the FASB assumed the responsibility for setting accounting standards-12% of the FASB's Statements give materiality percentages compared to 10% of the APB's Opinions, and 5% of the FASB's Statements give judgment items compared to 16% of the APB's Opinions. Interestingly, a pronouncement that specifies a percentage generally does not give a judgment item. In fact, only one pronouncement (SFAS 13) gives both a percentage and a judgment item.
A majority (nine out of 17) of materiality percentages are investment- related. These pronouncements provide standards of accounting for stock dividends, earnings per share, business combinations, investments, and segment reporting. The remaining pronouncements that give percentages relate to specialized accounting practices. For example, four pronouncements give materiality percentages for decisions involving related party transactions, foreign currency transactions, oil and gas accounting, or real estate transactions. Two pronouncements give materiality percentages related to leases and pensions, respectively.
The influence of the SEC and other government agencies is evident in several pronouncements that contain materiality percentages. When APB 15, APB 16, and APB 18 were issued (late 1960s and early 1970s), the accounting profession and the APB were coming under increasing political pressure. The SEC issued Accounting Series Releases (ASRS) pertaining to leases, pensions, related party disclosures, and disclosure of significant oil and gas related activities before the APB and the FASB also issued pronouncements in those areas. Indeed, when SFAS 25 was adopted, the FASB refused to adopt the SEC's 10% rule found in ASR No. 257. This rule is used to determine if a company has significant oil and gas related activities. When SFAS 69 was adopted, the SEC's 10% rule for determining significant oil and gas producing activities was included.
Are presented to assist practitioners in making the materiality decisions that are demanded in today's accounting and auditing environment.
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