The Risk Factor in Materiality Decisions

A study was made of the decision process employed by CPAs when resolving materiality issues. The hypothesis tested was that the decision reached concerning the materiality of an item is influenced by the degree of uncertainty about the final resolution of the issue and the CPA's willingness to accept the risk of an incorrect decision. The technique of cardinal utility curve analysis was used to examine the materiality decisions of nineteen partners of CPA firms. Responses were elicited to three independent hypothetical cases. Risk attitudes were observed by assessing utility values for the amounts involved and by comparing the subjects' responses with risk-neutral responses. The analysis revealed that in the two cases involving accounting matters, an average of 55.3 percent of the participants were risk-averse and 34.2 percent were risk seekers. The hypothesis of the study was accepted: the accountants tested were found to react aversely to uncertainty in materiality decisions.