HOMEWORK CHAP 33-31

For each of the following scenarios, perform the three steps in the materiality process: (1) determine overall materiality, (2) determine tolerable misstatement, and (3) evaluate the audit findings.

Scenario 1 :

Murphy & Johnson is a privately-owned manufacturer of small motors for lawn mowers, tractors, and snowmobiles. The components of its financial statements are (1) income before taxes = $21 million, (2) total assets = $550 million, and (3) total revenues = $775 million.

Determine overall materiality, and determine tolerable misstatement. Justify your decisions.

Because Murphy & Johnson is a privately-owned company, we should use 5% of net income before taxes. => Planning Materiality = $21 million × 5% = $1.05 million.

The planning materiality is not an extremely high number, so we will use 50% to help determine tolerable misstatement, as it is a safer value to use when calculating tolerable misstatements because it has a lower risk. => Tolerable Misstatement = $1.05 million × 0.50 = $525,000.

During the course of the audit, Murphy & Johnson’s CPA firm detected two misstatements that aggregated to an overstatement of income of $1.25 million. Evaluate the audit findings. Justify your decisions.

The auditor should advise the client to make relevant adjustments to the financial statements as the two detected misstatements are greater than the planning materiality. Both the misstatements should be booked in the financial statements if these statements are known misstatements. It is important for the auditor to understand the cause of the misstatements and how these misstatements would affect the auditor's assessment of risk.

Scenario 2:

Delta Investments provides a group of mutual funds for investors. The components of its financial statements are (1) income before taxes = $40 million, (2) total assets = $4.3 billion, and (3) total revenues = $900 million.

Determine overall materiality, and determine tolerable misstatement. Justify your decisions.

Delta is an entity in mutual fund, we should use 5% of net asset value => Planning Materiality = $4.3 billion × 0.5% =$21.5 million.

Tolerable Misstatement = 21.5 million × 0.50 = $10.75 million

During the course of the audit, Delta’s CPA firm detected two misstatements that aggregated to an overstatement of income of $5.75 million. Evaluate the audit findings. Justify your decisions.

The two detected misstatements are less than both tolerable misstatement and planning materiality so no adjustment to the financial statements would be necessary. However, the auditor should understand the cause of the misstatement and determine the impact of the misstatements on the auditor’s assessment of fraud and control risk. If either of the two misstatements were known misstatements, the auditor would request that the client make an adjustment. If Delta Investments is a public company, subject to Sarbanes Oxley 404 requirements; the misstatements may represent significant weaknesses in controls

Scenario 3:

Swell Computers is a public company that manufactures desktop and laptop computers. The components of the financial statements are (1) income before taxes = $500,000, (2) total assets = $2.2 billion, and (3) total revenues = $7 billion.

Determine overall materiality and tolerable misstatement. Justify your decisions.

Planning materiality = $2.2 billion × 0.5% = $11.000,000

Tolerable misstatement = $11.000,000 × 0.5 = $5,500,000

During the course of the audit, Swell’s CPA firm detected one misstatement that resulted in an overstatement of income by $1.5 million. Evaluate the audit findings. Justify your decisions.

The detected misstatement is less than both tolerable misstatement and planning materiality. However, in this instance, the adjustment of $1.5 million turns a profit into a loss, so an adjustment to the financial statements would be necessary. In addition, the auditor should understand the cause of the misstatement and determine the impact of the misstatements on the auditor’s assessment of fraud and control risk. If Swell Computer is a public company, subject to Sarbanes Oxley 404 requirements; the misstatements may represent significant weaknesses in controls