Revisions versus Restatements: Managerial Discretion in Materiality Assessments

Abstract

In recent years, firms reporting revisions of prior financial statements outnumber firms reporting restatements. Accounting rules require material misstatements to be transparently disclosed as restatements, whereas immaterial errors/irregularities can be reported as revisions. Given the discretion allowed in materiality assessments, I examine whether firms conceal material misstatements as revisions to avoid the negative consequences of formal restatements. Based on regulatory guidance and widely used materiality benchmarks, I find that almost 40% of revisions meet at least one materiality criterion. These “material” revisions elicit a more negative market response relative to immaterial revisions, suggesting that the market perceives these misstatements as consequential. I further find that misstatements that allow for high materiality discretion are more likely to be revised rather than restated and that these revisions are associated with managements’ strategic incentives. Specifically, these misstatements are more likely to be reported as revisions when the firm has compensation clawback provisions, strong capital market pressure, and when past performance is negatively impacted. In addition, I show a significant increase in the propensity to revise rather than restate after an SEC report that encourages even more discretion in the materiality assessment. Overall, my results suggest that materiality discretion can be used opportunistically to conceal material misstatements as revisions which has implications for the FASB's proposed change to materiality guidance.