The purpose of this study is to contribute towards a deeper debate about the concept of risk tolerance and its relationship with the principle of materiality relevant for the audit of internal controls over financial reporting. Despite the recognition of the fundamental role of the materiality principle in auditing, there is little guidance provided as to how this concept might be actually made and integrated in practice, thus leaving it up to the judgment of individual auditors and, residually, to an extension of the role of qualitative materiality concept. A review of the auditing literature also reveals relatively little research or discussion of the methodology of determining overall materiality levels. This study presents an empirical analysis in order to investigate how the particularity of an industry has a remarkable influence on the relative dimension of overall materiality measures. The empirical analysis is based on an inter-industry comparison of overall materiality measures with the same approach used in the Pany-Wheeler study (Pany and Wheeler 1989). We analyze the 4 most-used overall materiality thresholds (benchmarks and percentages) in order to investigate their size, ratios and stability over a time period of 10 years. The sample of annual reports refers to 2015 large and medium-size companies for the years 1997 through 2006; financial statements data represent 29 different industries. The findings provide evidence that the specific size and stability of the four materiality measures does not allow to elaborate an univocal decision pattern for the definition of materiality. We suggest further investigations on what are the characteristic processes in a specific industry and what are the main drivers that can explain their volatility over a period of time. As a consequence, our results indicate avenues for future research in the area of the relationship between tolerance measures and business processes characteristics.
The Risk Tolerance Concept for Internal Controls Over Financial Reporting in the auditors’ perspective: some empirical evidence from an inter-industry analysis of overall materiality measures
PECCHIARI, NICOLA;POGLIANI, GIUSEPPE
2008
Abstract
The purpose of this study is to contribute towards a deeper debate about the concept of risk tolerance and its relationship with the principle of materiality relevant for the audit of internal controls over financial reporting. Despite the recognition of the fundamental role of the materiality principle in auditing, there is little guidance provided as to how this concept might be actually made and integrated in practice, thus leaving it up to the judgment of individual auditors and, residually, to an extension of the role of qualitative materiality concept. A review of the auditing literature also reveals relatively little research or discussion of the methodology of determining overall materiality levels. This study presents an empirical analysis in order to investigate how the particularity of an industry has a remarkable influence on the relative dimension of overall materiality measures. The empirical analysis is based on an inter-industry comparison of overall materiality measures with the same approach used in the Pany-Wheeler study (Pany and Wheeler 1989). We analyze the 4 most-used overall materiality thresholds (benchmarks and percentages) in order to investigate their size, ratios and stability over a time period of 10 years. The sample of annual reports refers to 2015 large and medium-size companies for the years 1997 through 2006; financial statements data represent 29 different industries. The findings provide evidence that the specific size and stability of the four materiality measures does not allow to elaborate an univocal decision pattern for the definition of materiality. We suggest further investigations on what are the characteristic processes in a specific industry and what are the main drivers that can explain their volatility over a period of time. As a consequence, our results indicate avenues for future research in the area of the relationship between tolerance measures and business processes characteristics.
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