American Accounting Association 2006 Midwest Region Meeting March 30 – April 1 Chicago, Illinois

Friday, March 31, 10:20 a.m.-12:00 noon
Concurrent session 2D - SOX and Assessing Risk (Auditing)

Title: A New Approach to Assessing Materiality

Rebecca L. Rosner, Ph.D., CPA, CISA Long Island University - C.W. Post Campus	Christie L. Comunale, Ph.D., CPA Long Island University - C.W. Post Campus
Thomas R. Sexton, Ph.D. Stony Brook University

ABSTRACT: Recent accounting scandals and the subsequent increased regulation and standards require the auditor to take greater care in assessing the risk of material misstatements. We show that there may be value in considering the adoption of the fuzzy logic approach in making materiality assessments. Traditionally when auditors encounter misstatements during the course of an audit, they make a binary decision as to whether the misstatement is material or not, paying more attention to quantitative factors and less to qualitative factors. We propose a fuzzy expert system approach that assesses materiality as a continuous characteristic by allowing a misstatement to possess a degree of materiality between 0 and 1. This approach provides the auditor with more flexibility, greater precision, and deeper insight regarding subsequent testing and investigation. We provide a case study that compares the auditor’s use of the classical approach to the fuzzy logic approach. Using the classical approach, the auditor may consider all of the misstatements to be immaterial both individually and in aggregate, be less likely to closely scrutinize the misstatements or expand the audit in these areas, and more likely to overlook red flags of the risk of fraud. On the other hand, incorporating the fuzzy logic approach allows the auditor to make different assessments, relative to both quantitative and qualitative factors, for each misstatement.

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