Hagia Electronics, Inc., operates a chain of consumer electronics stores in the Dallas area. This year the company achieved annual sales of $75 million, on which it earned a net income of $3 million. At the beginning of the year, management implemented a new inventory system that enabled it to track all purchases and sales. At the end of the year, a physical inventory reveals that the actual inventory was $120,000 below what the new system indicated it should be. The inventory loss, which probably resulted from shoplifting, is reflected in a higher cost of goods sold. The problem concerns management but seems to be less important to the company’s auditors. What is materiality? Why might the inventory loss concern management more than it does the auditors? Do you think the amount of inventory loss is material?

Interpreting Financial Reports Comparison of Profitability