Begin Company was organized in January of 19X7. The company is in the business of taking computer chips from discarded personal computers and making vases and other items that are used to decorate residences.

Begin had managed to raise \(\$ 200,000\) from the sale of capital stock and \(\$ 400,000\) by borrowing on a long-term note. In \(19 \times 8\), it borrowed another \(\$ 50,000\) on a long-term note. However, certain provisions in the notes give the bank the right to call the notes if the current ratio falls below 2 to 1 in the balance sheet issued at the end of the second year of operations.

By using skillful marketing techniques and holding down expenses, the company was "in the black" by 19X8. However, federal authorities had cited Begin several times for paying its employees less than the required minimum wage.

In late 19X8 Begin engaged a CPA firm to audit its financial statements, parts of which are shown in Figure 7.1 and 7.2. During the planning stages of the audit, the CPA firm decided that the threshold of materiality would be a misstatement of income before income tax expense of \(\$ 10,000\).

Required:

a. Using the amounts in Figures 7.1 and 7.2 assign the materiality of \(\$ 10,000\) to the appropriate accounts in the financial statements. Supply a written justification for the tolerable misstatement assigned to each account. If you did not assign some of the \(\$ 10,000\) to certain accounts, explain why.

b. For each of the accounts to which you assigned some of the \(\$ 10,000\) of materiality, indicate what steps you might take if the misstatements found in the account exceeded, by a small amount, the tolerable misstatement assigned to that account.

c. Assume that, after aggregating the misstatements in each account, the total is \(\$ 11,000\). What are the possible actions you could take? Indicate the advantages and disadvantages of each possible course of action.

d. Assume that, after aggregating the misstatements in each account, the total is \(\$ 15,000\). In what way, if any, would your possible courses of action be different from the possible courses of action you might take in situation

(c) above?

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FIGURE 7.1 Income Statement Begin Company Income Statement For the Year Ended December 31, 19X8 Sales Cost of goods sold Beginning inventory $300,000 Purchases 580,000 Cost of goods available for sale $880,000 Less: ending inventory 280,000 Gross margin Operating expenses Income before income tax expense Income tax expense Net income $1,000,000 600,000 $ 400,000 300,000 $ 100,000 30,000 $ 70,000