Evidence on Auditor and Investor Materiality Thresholds Resulting From Equity-For-Debt Swaps.

Abstract

Abstract Despite the user-oriented nature of the concept of materiality, little research addresses how financial statement users' implied materiality judgments correspond with auditors' implied materiality judgments. We descriptively investigate this issue using archival data from equity-for-debt swap transactions that occurred during the 1980s. The income statement classifications of gains that arose from swaps as either ordinary or extraordinary income were a function of the materiality of the gain. We document a positive association between firms' income statement classifications of these gains and the strength of the capital market's reaction to the announcement of the equity-for-debt swaps. Also, contrary to the evidence from other materiality studies employing archival research methods, our evidence indicates that the income statement classification of these gains, as ordinary or extraordinary income, follows closely a conventional percentage-of-income, materiality rule-of-thumb.