Question

Define materiality as it is used in Chapter 7 ( Earnings Management) .  How does materiality come into play when assessing financial statement restatements?  Other than materiality, what is the one word that might be the most distinguishing factor between ethical earnings management and unethical earnings management?

Answer 1

Materiality is the threshold above which missing or incorrect information in financial statement is considered to have an impact on the decision making of users. Materiality is sometime construed in terms of net impact on reported profits, or the percentage or dollar change in a specific line item in the financial statements. Examples of materiality is as follows:

(A company earns a profit of $20000 which is the point at which earning per share exactly meet analyst expectations. Any reduction in the profit below this point would have triggered a sell of companies share and so would be considered material)

If the error occurs in the preparation of financial statements knowing it to be material to such statements. Those statements are then required to be corrected for a true and fair presentation of the financial statements of the organisation and are reissued to the users of such statements. Here, materiality is determined if the error or such misinterpretation lead the users to come to incorrect decision or the conclusion in their analysis.

One word that might be the most distinguishing factor between ethical earnings management and unethical earnings management apart from materiality is the Intent of the Management when making financial reporting decision since the intention of the financial managers are unknown to the users of the financial statements which existed between financial planner who know their purpose of taking decision and users who lack insight into underlying reporting.