Jacoby and Levy’s probing article “The Materiality Mystery” (July 2016, p. 14) raises perhaps the most important question in auditing: What does “material” really mean? The terminology is daunting. “Material,” “materiality,” “accounting materiality,” “auditing materiality,” “performance materiality,” and “tolerable misstatement” now litter the professional landscape. Why?
It’s as if the standards setters are real-life versions of the proverbial blind men who tried to describe an elephant. As a practitioner-turned-academic who was trained in engineering and applied statistics as well as accounting, I can only shake my head in dismay at the standards setters’ collective ignorance of quantitative matters. Jacoby and Levy point out that the confusion the standards setters sow renders too many pronouncements involving materiality a mystery. In my opinion, the related guidance is worse than useless.
Yes, there are qualitative issues, too. The authors cite the example of a company on the cusp of a default on a debt covenant. Nevertheless, those qualitative issues invariably find quantitative expression, and vice versa. Dare one ask for disclosure? The standards setters should not take the presence of qualitative issues as an excuse for dodging the issues raised in the article.
Part of the problem is definitional, but another part is disclosure. Fourteen years ago, in the wake of the Enron scandal, Andy Kessler wrote in the Wall Street Journal (“Listing in a Material World,” Feb. 25, 2002, http://on.wsj.com/29JXnLZ), “This whole accounting mess can be cleared up by simply defining the word materiality. … When a company releases earnings, it should be required to include its materiality threshold. Want to stay at 10%? Fine, just tell me.”
Are Jacoby, Levy, and I the only people who paid attention to Kessler? Sadly, the answer appears to be “Yes.”