Materiality disclosure and litigation risks: A Canadian perspective

Abstract

This article investigates the perceptions of auditors (accounting firms), preparers (industry) and users (banks) of financial statements on the disclosure of a materiality list using the survey method. The materiality list is a subjective compilation by the auditor of unadjusted differences such as misstatements, omissions and rounding calculations that on an individual basis would not be considered material. Our survey results show that users agree with the disclosure of materiality lists and do not believe that a materiality list will expose preparers and auditors to litigation risks; users believe that a materiality list will reduce the risk of litigation, facilitate investment in stocks, reduce the cost of capital and usher in financial stability. On the other hand, we find that auditors disagree with users of financial statements with respect to disclosure and risk of litigation. In addition, we find that the perception of auditors, preparers and users is not influenced by factors such as gender and work experience. These results come from a sample set of a total of 501 survey questionnaires sent to bank, industry and accounting firms across Canada with 167 returned responses. These findings indicate a disconnect between users and the preparers and auditors of financial statements that should be fixed. That is, investors and analysts (among the users) of financial reports need to know how materiality is being defined and are not satisfied with the status quo currently defined by accounting and securities regulators. Preparers and auditors could achieve greater clarity in financial reports by articulating what it takes for a transaction to be classified as material. This materiality standard may best be accomplished by the creation of a materiality list.