Blog FASB Financial Reporting Materiality Opinion

Empirically Analyzing the “Five Percent Rule of Materiality” in Financial Reporting Decisions

This research analyzes a sample of financial restatements from 2011 and 2012 as a solution to assess a proposed “five percent rule of materiality” for financial reporting selections.  Such a rule claims the average investor is simply influenced by revenue restatements higher than 5 %.  Market reactions are noticed by means of stock worth, quantity, and bid-ask spread following the restatement in the Type 10-Okay/A.  The research finds just some companies restating internet revenue by more than 5 % experience statistically vital reactions in two of these metrics.  The research also suggests % change in internet revenue is a big driver of % change in the three metrics by way of a regression evaluation.  This research makes use of publicly obtainable info and may only look at companies the place an auditor has already determined that the restatement was material.  There isn’t any examination of companies the place an auditor determined that it was immaterial and didn’t problem a restatement.  The “five percent rule of materiality” explains rather a lot of what is noticed in earnings restatements.  As this is an area of much debate among practitioners, regulators and teachers need to offer higher steerage about the willpower of materiality.


This research examines financial restatements as a foundation for exploring the concept of materiality.  The undertaking evaluates the appropriateness of the “five percent rule of materiality,” a decision-making device which assumes the rational, average investor is simply influenced by variations in reported internet revenue higher than five % (Vorhies, 2005).  To check whether or not this rule holds, the research examines market reactions from a pattern of five corporations.  These corporations are selected from all restatements occurring between 2011 and 2012 which include widespread characteristics of 4.02 non-reliance and revenue recognition as the driver for the restatement.

To check the 5 % rule, market reactions are observed following the release of the Type 10-Okay/A by means of three metrics: stock worth, volume, and bid-ask spread.  A statistical check of means yields vital reactions in inventory worth and volume for three of 4 corporations restating internet revenue by an quantity more than five %. The final firm in the sample, which restates internet revenue by lower than one %, produces no vital response in these variables.  No companies in the pattern create a big response in the bid-ask spread variable.  Consequently, this means such a five % rule shouldn’t be applicable in figuring out materiality thresholds for monetary reporting.  Similarly, regression evaluation means that % change in internet revenue is a statistically vital unbiased variable in determining the magnitude of the reaction in every metric.


Historical Background

Financial reporting seeks to offer relevant, reliable, comparable, and consistent info to buyers and collectors so they could analyze performance and undertaking money flows to the enterprise (Financial Accounting Requirements Board, 2010).  The complicated organizations that take part in this reporting need to determine the info needed for its buyers and creditors to guage efficiency and forecast money flows.  This drawback is one of materiality.  In accounting, info is taken into account materials if, based mostly on its nature, magnitude, or each, it will affect the selections of financial assertion users (Financial Accounting Requirements Board, 2010).

Over time, management began to develop advert hoc instruments for shortly assessing this query of materiality.  Quickly, the benchmark for materiality turned fixated on fluctuations higher than 5 %, notably with regard to internet revenue (Vorhies, 2005).  After some “frustration that had built up over the years” (Barlas et al 1999) relating to an obvious reliance on comparable guidelines of thumb, the Securities and Change Fee (SEC) issued Employees Accounting Bulletin (SAB) No. 99 – Materiality, in August 1999.  In this publication, the SEC urges managers and auditors to recall that, when determining materiality, strict reliance on “any percentage or numerical threshold has no basis in the accounting literature or the law” (U.S. Securities and Trade Commission, 1999).  Future analysis would conclude that, in common, financial statement customers carry a decrease materiality threshold than do preparers and auditors (Messier, et al 2005), further perpetuating the want of a definite threshold for practical purposes.

Scholarly Context

The Financial Accounting Requirements Board (FASB) supported SAB 99 in its 2010 amended publishing of Concept Assertion No. Eight.  The FASB writes, “The Board [FASB] cannot specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation” (Financial Accounting Requirements Board, 2010).

Following accounting scandals from the early 2000s and subsequent passage of the Sarbanes-Oxley Act in 2002, correct identification and disclosure of material info resurfaced as a key concern dealing with the accounting career.  Almost six years after the release of SAB 99, James Vorhies, CPA, revealed an article in the Might 2005 Journal of Accountancy titled “The New Importance of Materiality.”  This piece highlights the significance of materiality in management’s efforts to comply with Sarbanes-Oxley requirements for reporting on danger and inner control.  Vorhies chronicles accountants’ use of the 5 % rule and grounded it as a “fundamental basis for materiality estimates” (2005).  He also echoes the SEC’s 1999 message in SAB 99 by noting the inappropriateness of relying on a numeral target in figuring out materiality and stressing the use of qualitative elements.  He claims the drawback lies in the analysis of qualitative elements as a result of of their complexity and immeasurability; subsequently, he states professionals still depend on quantitative parts in figuring out probably material info (Vorhies, 2005).

Vorhies’ dialogue sparked a spirited response in the Journal of Accountancy’s August 2005 challenge from Steven Johnson, CPA.  Johnson worries Vorhies’ language implies an authoritative 5 % rule and would go away readers believing misstatements lower than five % don’t have an effect on a company’s general monetary presentation.  He consequently argues its use in apply as an inner start line solely and not really a “rule” (Johnson, 2005).

A research at New York College seeks to deal with both quantitative and qualitative characteristics of financial restatements and their short-term market reactions.  Research concludes stock costs are negatively associated to the restatement’s magnitude; the greater the restatement amount, the higher unfavorable market reaction. Equally, stock costs are likely to react more considerably when the nature of the restatement is both fraud or income recognition (Wu, 2002).  Wu’s findings that fraud and income recognition restatements cause the largest reactions are also supported by research at the College of Kansas (Scholz, 2008).

Researchers at the University Valahia of Targoviste in Romania broaden on previous critiques of the 5 % rule by putting it in context with the function of financial reporting.  While previous authors condemned the rule as inadequate as a result of of its emphasis on quantitative elements only, these researchers rehash the previous arguments and further claim that it fails to assist buyers and creditors in their analysis of firm’s financial knowledge (Cucui et al., 2010).  These similar researchers additionally argue towards the use of a 5 % benchmark and, like regulators, emphasize the customers of financial knowledge and promote a materiality definition that’s rooted in altering their determination making process (Cucui et al., 2010). This serves as help to the SEC and FASB position further by emphasizing the core objective of monetary reporting.

Research Basis

The thought to research the five % rule sprouted from the examination of a restatement by JetBlue Airways in February 2011.  The restatement resulted in a constructive improve in 2009 internet revenue by just over five %.  To know more utterly the implication of the five % rule beyond this singular software, it was determined to broaden the sample measurement by finding different monetary restatements which mimic the characteristics found in the JetBlue restatement announcement.  These characteristics embrace the following:

  • 4.02 non-reliance on previously issued financial assertion
  • Revenue recognition as the driving pressure for restatement
  • Restatement filed in 2011-2012

Educational Contribution

Previous work on the 5 % materiality rule indicates an general opposition as a result of of a non-reliance on qualitative elements, very similar to the SEC and FASB statements. Others try and determine these qualitative elements by creating helpful profiles of corporations that can anticipate damaging reactions based mostly on the sort and magnitude of monetary restatement. This research will add to the present body of information by statistically analyzing the 5 % rule as a place to begin for understanding materiality in monetary reporting.


Materiality is a minimum of a twofold concept containing both qualitative and quantitative elements.  This research appears for help for a quantitative impact and the sample is chosen to isolate the effect.  First, all revenue restatements are chosen because prior analysis has shown that buyers discover income restatements materials (Wu, 2002).  Without this criteria, it might be unimaginable for us to seek out any restatements that fall under 5% if the 5% rule holds in apply.  Put another method, if an auditor found an error but judged it to not be material because it was lower than 5% there would not be an 8-Okay or an investor response to review.  Secondly, the Eight-Okay announcement needed to incorporate the language of a income restatement but not embrace any quantitative numbers.  This enabled us to separate the reaction to the revenue restatement (qualitative) and the response to the magnitude (qualitative).Finally, the 10-Okay/A was the first disclosure of the numbers necessary to determine the magnitude of the restatement.

For those restatements in this pattern, all % modifications in internet revenue are disclosed in the Type 10-Okay/A moderately than the Type 8-Okay.  It’s anticipated that the market reacts considerably following the Type 8-Okay because this is the type that categorizes the restatement as one of income recognition which, prior research exhibits, engenders a big market reaction (Wu, 2002). Subsequently, it’s anticipated that any vital response following the Type 10-Okay/A is due to the magnitude of the internet revenue restatement; subsequently, the Type 10-Okay/A date serves as the central date in the research’s evaluation.  The development of the pattern consequently is designed to aim to isolate the reaction as a result of revenue recognition (around the Type Eight-Okay) from the reaction resulting from the magnitude of the revenue restatement (around the Type 10-Okay/A) so as to assess the 5 % rule more precisely.

Furthermore, a constructive relationship is predicted between the magnitude of the internet revenue restatement and the magnitude of the market response (round the Type 10-Okay/A). To assess these expectations, six testable hypotheses are developed under, two for each metric, from which to attract ultimate commentary relating to materiality.

Stock Worth

Inventory worth is an indicator of the investing public’s perceived value of an organization. With devaluation of a company comes a want to sell, growing supply of the stock in the market.  Economics explains that, different things equal, elevated supply drives down costs.  Based mostly on this, the following are proposed:

  • H1A: For restatements with four.02 non-reliance and revenue recognition citations without quantitative knowledge disclosure, the stock worth will decline significantly round the issuance of the 10-Okay/A for restatements above and under 5% of internet revenue.
  • H1B: Following the 10-Okay/A disclosure, a higher inventory worth decrease won’t be related to a bigger magnitude of the restatement.

H1A pertains to the market reaction to the magnitude of the restatement.  All corporations have beforehand issued an 8-Okay outlining the need for a restatement associated to income but not disclosing the magnitude.  The hypothesis is said in null type in accordance with SEC and other authoritative bodies that materiality is just not based mostly on a quantitative standards.  Nevertheless if we discover evidence that there isn’t a vital response for corporations under 5% (absolute value) but a there’s one for these above 5% (under -5%), it supports a more practitioner based mostly principle that small restatements aren’t of interested to buyers.  H1B can also be said in null and speaks to the spirit of the 5% rule or a graduated materiality.  A constructive vital response suggests that the higher the magnitude the larger the materiality.  We anticipate this to carry in each the constructive and unfavorable quadrants.


Quantity is an indicator of an investor’s willingness to hold on to a inventory.  Accordingly, it is anticipated that volume reacts more severely when restatements are bigger than 5 %.  Consequently, the following are anticipated:

  • H2A: For restatements with four.02 non-reliance and revenue recognition citations, the volume will improve significantly round the issuance of the 10-Okay/A for restatements above and under 5% of internet revenue.
  • H2B: Following the 10-Okay/A disclosure, the magnitude of the volume improve will probably be positively associated with the magnitude of the restatement.

H2A exams materiality by method of the investor’s willingness to carry.  A cloth disclosure should outcome in a change in the willingness to carry of buyers.  Some buyers can be extra prepared to hold, others less and this modifications creates more transaction quantity between buyers.  The speculation is said in null, according to the SEC assertions that materiality is just not based mostly on a quantitative criteria.  The 5% materiality rule means that only these with restatements higher than 5% (absolute value) of internet revenue will get a big change in volume.  Restatements under that will not change the willingness to carry of buyers.  H2B is said in null and speaks to the graduated materiality based mostly on magnitude.  The magnitude of the restatement is check in absolute worth terms as a result of a both giant constructive or adverse response might change an investor’s willingness to hold.  Regardless of whether or not willingness to carry will increase or decreases, the outcome is a rise in volume.  A big constructive relationship suggests that the larger the restatement the larger the change in investor’s willingness to hold the stock.

Bid-Ask Spread

The bid-ask unfold represents the distinction between the worth a market maker or clearing home is prepared to pay for a safety (bid) and the worth at which a it needs to promote that security (ask).  The bid-ask unfold additionally signifies a inventory’s volatility or danger.  The more risky or risky the security, the more revenue is demanded by the market maker to hold the inventory.  Accordingly, bigger bid-ask spreads are expected for larger proportion restatements in internet revenue surrounding the 10-Okay/A disclosure.

  • H3A: For restatements with four.02 non-reliance and revenue recognition citations, the bid-ask spread will improve considerably around the issuance of the 10-Okay/A for restatements above and under 5% of internet revenue.
  • H3B: Following the 10-Okay/A disclosure, the magnitude of the bid-ask unfold improve can be positively related to the magnitude of the restatement.

A cloth restatement might change the perception of danger of a company.  H3A is said in null in line with the SEC’s assertions that materiality is just not based mostly on quantitative criteria.  Vital modifications in bid-ask spread, recommend modifications in danger perceptions and if we discover evidence of this for restatements above 5% (absolute worth) of internet revenue and not under then we find help for the practitioner’s principle that 5% is materials by means of modifications in the danger notion.  H3B is said in null and speaks to the concept of graduated materiality. A constructive vital response means that the larger the restatement as a % of internet revenue the higher the change in the danger notion as measured by means of the bid-ask unfold.


The development of the sampling procedure to the remaining pattern used in this research, as well as primary overview info for these companies, might be found in Determine 1 Panel A.

Figure 1 Panel B supplies further overview info for the whole ultimate pattern as a collective.  The descriptive statistics proven are based mostly on the ten days prior to the standards disclosure date and the three days following the criteria disclosure date.  The ten-day-prior window establishes a baseline for comparison whereas the three-day-after window is designed to capture market reactions, assuming a semi-strong market (Fama, 1970).

As outlined, there are two hypotheses to be tested for each metric: inventory worth, quantity, and bid-ask spread.  The first of these hypotheses offers with the significance of modifications in these metrics before and after the 10-Okay/A disclosure.  To research this significance, internet revenue knowledge are pulled from the unique Type 10-Okay as well as Type 10-Okay/A for each company to calculate the proportion change. Historic worth, volume, and bid-ask knowledge are drawn from the Middle for Research in Securities Costs (CRSP) database.  The info are then used to perform a check of means for each metric to gauge the significance of modifications in these metrics earlier than and after the 10-Okay/A disclosure.

Like the combination sample knowledge offered in Determine 1, the check of means knowledge – found in Figure 2 – calculates the baseline common over a ten day interval whereas the reaction window is calculated over a three day period.  Three days is used for the reaction window as a result of of the assumption of a semi-strong market in which the market internalizes info less than instantaneously (Fama, 1970).  The p-values are calculated utilizing Welch’s adjusted levels of freedom assuming unequal variances between the ten-day-prior interval and the three-day-after window (Doane & Seward, 2010).

The second speculation for each metric revolves around the relationship between the magnitude of the proportion change in revenue and the magnitude of the observed movement in the metric.  To test this, all companies are combined and three separate regressions are run with proportion change in internet revenue as the unbiased variable and proportion change in each individual metric as the dependent variable.  For the quantity and bid-ask unfold regressions, the absolute values of the proportion modifications in internet revenue are used.  That is executed because the evaluation is concentrated on magnitude of the restatement, not path.  Nevertheless, the magnitude of worth is direction-dependent, so the proportion change in revenue used in that regression might be each constructive and damaging.

Two sets of regressions are included, one with an “outlier” and one without it.  This potential outlier is American Superconductor.  The company was identified as a possible outlier as a result of it’s the only firm whose proportion change in internet revenue is bigger than one commonplace deviation away from the sample common (see Figure 1).  Because of the small sample measurement, this potential outlier was not calculated utilizing the internal quartile range (Doane & Seward, 2010); subsequently, the outcomes of both regressions are included for each metric in Figure three to facilitate full disclosure.  Equally, the proportion change in internet revenue is calculated barely in another way for American Superconductor than the other choices as a result of it outcomes in a restatement across three quarters, not one full yr.  The change in revenue is subsequently based mostly on a nine-month cumulative effect.


This section presents the research’s results and revisits each of the six hypotheses previously developed to research them in the context of the 5 % rule for materiality.

Significance of Market Reactions – Checks of Means

Results for the significance of market reactions captured in every of the three metrics by way of the check of means could be found in Figure 2.

Figure 2 - Test of Means

  • H1A: For restatements with 4.02 non-reliance and revenue recognition citations, the stock worth will react considerably to the info.

As proven in Panel A on Determine 2, at an alpha degree of .05, three of the 5 companies in this sample generate a big inventory worth response round the Type 10-Okay/A. In line with the 5 % rule, these three companies restate internet revenue by more than five %.  Of specific interest is JetBlue Airways, whose internet revenue restatement is simply over 5 %, because its p-value is equally simply decrease than .05.  This means a crucial point in which proportion change and response significance converge, in step with the 5 % rule.  Put simply, the % change in revenue is barely over 5 %, and its inventory worth response is barely statistically vital.

The predictive energy of the five % rule doesn’t apply in the instance of Zoo Entertainment.  This firm restates internet revenue by properly over 5 %, but the stock worth reaction isn’t vital even at a .10 alpha degree.  It ought to be famous that, although the Type 10-Okay/A discloses the true restatement amount, the info contained in its Type Eight-Okay complicates the analysis.  This manner includes a schedule of estimated re-casted monetary statements given the 4.02 non-reliance.  This knowledge proved to be incorrect and the extra correct monetary impression was truly released in the Type 10-Okay/A.  Despite this info, the Type 10-Okay/A continues to be used in the evaluation because it will be inconceivable to differentiate whether or not any noticed reaction round the Type 8-Okay resulted from the sort of restatement (income recognition), which research has already shown to be a big issue in market response (Wu, 2002), or from the % change restatement.

The ultimate firm, Monsanto Company, yields the most insignificant inventory worth reaction and is the solely selection with a internet revenue restatement under five %.  This prevalence is in keeping with the five % rule.  General, logic of the 5 % rule applies to four of 5 corporations in this pattern.

  • H2A: For restatements with 4.02 non-reliance and revenue recognition citations, volume will improve considerably.

The info on Panel B of Determine 2 can be utilized to deal with the question of significance in volume reactions.  Of the five companies in the pattern, solely two of them generate vital quantity reactions at a .05 alpha degree; a 3rd is added to this group when analyzed at a .10 alpha degree.  These are the similar three companies found to supply a big stock worth reaction in Panel A.  Once more, Zoo Entertainment appears to be an exception to the 5 % rule with an revenue restatement properly above five % however an insignificant quantity reaction.  Monsanto Firm, the selection with an revenue restatement lower than five %, generates a high p-value on this metric, suggesting statistical insignificance.  That is additionally in line with the five % rule in that such a low revenue restatement should engender an insignificant market response.  As with the earlier metric, the rule appears to use to solely 4 of five companies in the pattern.

  • H3A: For restatements with four.02 non-reliance and revenue recognition citations, the bid-ask spread will improve significantly.

As proven in Panel C of Determine 2, none of the companies create a big bid-ask unfold reaction following the Type 10-Okay/A launch at a .05 alpha degree.  Just one response becomes statistically vital at a .10 degree.  Monsanto Firm, nevertheless, still produces the most insignificant reaction of all 5 companies.  General, the 5 % rule does not seem to use to any companies in the pattern when bid-ask spread is used as a metric for capturing investor reaction.  The shortage of a big reaction in the bid-ask spread might outcome from the 5 % rule’s emphasis on common buyers.  The spread is decided by market makers and institutions that act between people and the market.  The typical investor, nevertheless, might not interact by way of these intermediaries or might take part by way of relatively tangential intermediaries; subsequently, their impression and determination making will not be captured adequately in this metric (Hollifield et al, 2011).

Magnitude of Market Reactions – Regression Evaluation

The regression coefficients, drawn from regressions operating % change in internet revenue towards % change in the given metrics, are in Determine 3.

Figure 3 - Regression Analysis

Each regressions, with and with out the potential outlier, yield a big unbiased variable for the inventory worth metric assuming a .05 alpha degree.  The unbiased variables for volume and bid-ask unfold, nevertheless, are solely vital at a .05 degree when the potential outlier is omitted.

  • H1B: Following the 10-Okay/A disclosure, a larger inventory worth lower might be associated with a bigger magnitude of the restatement.

As shown in Figure three, % change in internet revenue acts as a big unbiased variable at a .05 alpha degree when % change in worth is the dependent variable, each with and without the potential outlier.  Each regressions yield robust coefficients of willpower (r2), suggesting high predictive value.  Equally, the intercept in both regressions are near zero, which means no change in internet revenue ought to cause little to no change in worth.  This model makes financial sense and lends benefit to the basis of the 5 % rule: the idea that larger % modifications in revenue drive increased market reactions.

  • H2B: Following the 10-Okay/A disclosure, the magnitude of the quantity improve will probably be positively related to the magnitude of the restatement.

Referring to Determine three, % change in revenue is a big unbiased variable at a .01 degree, with % change in volume as the dependent variable, when the potential outlier is omitted from the sample.  Equally, the intercept falls much nearer to zero with out the outlier, making extra economic sense because a zero % change in internet revenue shouldn’t produce an increase in quantity when different issues are equal.  Moreover, the coefficient of willpower drastically increases when the model excludes the outlier, suggesting a greater fit and better predictive value.

  • H3B: Following the 10-Okay/A disclosure, the magnitude of the bid-ask unfold improve might be positively associated with the magnitude of the restatement.

The final columns in Determine three show regression knowledge when % change in bid-ask spread is the dependent variable in the analysis.  With the outlier omitted, the significance of % change in internet revenue as the unbiased variable drastically increases.  Similarly, the coefficient of willpower more than doubles from the regression that included the potential outlier, as soon as once more suggesting a better goodness of match and a better predictive value for the mannequin general.  With out the potential outlier, the intercept truly moves farther away from zero, which is not sometimes anticipated given the variables at play.


The first three hypotheses (H1A, H2A, and H3A) search to examine the 5 % rule immediately by measuring market reactions to internet revenue modifications firsthand.  Of the five choices in the pattern, the “rule” appears to use to all of them besides Zoo Leisure when analyzing modifications in stock worth and volume.  Of those four, the three companies restating revenue by more than five % experience statistically vital modifications in inventory worth and quantity.  The fourth agency, which restates revenue by less than five %, yields the most statistically insignificant modifications in inventory worth and volume.  The rule doesn’t seem to use to the remaining firm, Zoo Entertainment, regardless of its change in internet revenue beyond 5 %.  The fact that the rule matches only four of 5 companies lends credit score to the SEC and other regulatory authorities that have spoken out towards the use of a hard-and-fast quantitative materiality rule that can be applied to all monetary restatements.

Though the singular exception of Zoo Leisure discredits the five % rule after analyzing the inventory worth and volume, one would nonetheless anticipate an identical reaction for bid-ask spread even when not perfectly in line with the rule.  The potential for a scarcity of average investor contribution to the bid-ask unfold metric might assist clarify the complete lack of vital response round the variable.

The second set of hypotheses (H1B, H2B, and H3B) revolves round the magnitude of the internet revenue restatement as a driver of the magnitude of change in the given metrics.  This may be thought of as the logical foundation for the five % rule; that’s, buyers will react less significantly to smaller revenue restatements and will react to larger revenue restatements extra considerably.  The next regression analysis used to test this logical basis suggests that, with the potential outlier excluded, % change in internet revenue is a big unbiased variable in predicting the % change in each metric.  This, broadly speaking, proposes a big relationship between internet revenue and the chosen metrics.  This contribution, nevertheless, is rather more basic in nature than the former evaluation.  It does not search to examine the 5 % rule instantly, but slightly the underlying financial reasoning behind the rule.

A synthesis of these conclusions yields a bigger conclusion about this research as an entire.  The aim is to assess the five % rule as a proposed materiality commonplace.  The statistical check of means and subsequent outcomes in Figure 2 present that the rule is just not an authoritative principle in all purposes.  The singular exception of Zoo Leisure attests to this.  This rule, nevertheless, does retain logical help in its financial underpinnings.  The latter evaluation and results, found in Figure three, set up a fairly robust direct relationship between % change in internet revenue and % change in numerous metrics.

Given these conclusions, several suggestions may be ascertained as to greatest practices when dealing with materiality.  Firstly, this research’s regression evaluation suggests that companies should anticipate higher market reactions as restatements in revenue improve.  This, nevertheless, shouldn’t influence the actual choice in determining what is or is just not materials for disclosure functions.  Equally, five % has proven not to be an all-encompassing benchmark for materiality.  As the authoritative literature claims, materiality stretches past quantitative elements.  Buyers might find revenue restatements lower than 5 % to be material and, conversely, might find restatements larger than 5 % to be immaterial, as is the case in the instance of Zoo Entertainment.  Despite entry to completely rational financial knowledge, buyers can nonetheless act irrationally and are equally influenced by quantitative elements like government policy or perceived danger developments (Alnajjar, 2013).  Nonetheless, 5 % might serve decision-makers as a useful start line for assessing the severity of market reactions.

This research does help the 5 % rule as it is articulated in a literal sense.  In this pattern, buyers have been indeed only influenced by fluctuations in revenue higher than five %.  Nevertheless, the rule’s essence is its use as a software for delineating the material from the immaterial. When analyzed in this mild, it is clear that the rule fails to separate material and immaterial reactions merely based mostly on the % change in revenue.  As a result of of this prevalence, the rule just isn’t advisable to be used as a information in figuring out materiality for financial reporting.  It does, nevertheless, lend insights to predicting investor reactions.  Usually, most choices in this research’s sample are likely to react significantly to restatements greater than five %.  Although this is not authoritative for exterior use, administration can discover value in this data through the use of it to plan courses of motion to counter potential investor responses.


Regardless of this research’s suggestions and conclusions, some limitations have to be discussed.  The most obvious limitation is the small pattern measurement.  As Determine 1 portrays, the unique intent was to include a large pattern of companies in the analysis.  Resulting from numerous issues in knowledge collection and reporting, the pattern shortly dwindled down to 5 companies given the other quantitative criteria.

Inside this sample, just one company restated internet revenue by lower than 5 %.  A higher number of companies with smaller restatements in internet revenue would have aided the evaluation by making an attempt to determine material reactions for comparatively small restatements.  Conclusions reached relating to the rule, as written, can be stronger if such knowledge had been obtainable.  Nevertheless, if the five % rule is certainly getting used in apply, such a phenomenon can be anticipated.  If auditors and decision-makers deem internet revenue restatements less than five % to be immaterial, such sample alternatives can be unattainable for testing.

Equally, this research does not consider other elements that would affect the metrics at the time of the criteria disclosure.  As such, the regression analysis is an easy regression assuming one unbiased variable.  Prior analysis exhibits buyers may be influenced by qualitative info; nevertheless, they don’t seem to be included in the regression analyses.  As an alternative, the regressions have been stored easy to determine relationships between variables more clearly.

Lastly, one selection in this pattern, American Superconductor, released early yet inaccurate estimates in its Type 8-Okay.  This partially contaminates its true disclosure date as partial info was launched earlier than the Type 10-Okay/A.  Consequently, market reactions might have already occurred round the Type Eight-Okay; nevertheless, measuring around this manner would show troublesome in analyzing as the reaction might be resulting from its proportion change in revenue or its sort as a revenue recognition restatement.  Nonetheless, the market didn’t receive restatement knowledge for the first time on the day of the Type 10-Okay/A, which might have impacted the values of the knowledge collected.


Adam Morgan
PricewaterhouseCoopers LLP
Assurance Associate

Mariah Webinger, PhD
John Carroll University
Division of Accountancy
[email protected]
20700 North Park Blvd
University Heights, OH 44118

Works Cited

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Courtesy of Mariah Webinger