In this mini-case, you will determine overall materiality as well as tolerable misstatement amounts for balance sheet accounts of EarthWear Clothiers, Inc. Most auditing firms
In this mini-case, you will determine overall materiality as well as tolerable misstatement amounts for balance sheet accounts of EarthWear Clothiers, Inc. Most auditing firms use a simple approach for establishing planning materiality and tolerable misstatement similar to the one illustrated in your textbook. This case illustrates such an approach, with some additional guidance from Willis & Adams relating to the amount of tolerable misstatement to allocate to various balance sheet accounts based on difficulty to audit and expected misstatement, and limiting the total amount of tolerable misstatement to about ten times materiality.
INSTRUCTIONS:
Following the Materiality Guidelines for Willis & Adams CPAs, complete all the necessary fields on Work Paper 3-7 and 3-8. For your Convenience, EarthWear Financial Statements have been included for reference. Balance Sheet. Income Statement. Cash Flows. Shareholders Investments. Five-Year Financial Summary.
EARTHWEAR CLOTHIERS | 3-7 | |||
Unaudited | ||||
1. Benchmark Data | 2016 | 2015 | ||
Sales / Revenue | $10,19,890 | $9,50,484 | ||
Pre-tax income | $70,154 | $35,757 | ||
Total assets | $3,89,428 | $3,29,959 | ||
Materiality | $1,800 | |||
2. Establish Planning Materiality Level | ||||
Measurement Base | 70,154 | |||
(Click to select)Sales / revenue-tax income total assets | ||||
Percentage Applied* | 4.5% | |||
Planning Materiality | $3,157 | |||
Bases and Percentage Ranges: | ||||
Profit Oriented Entities | ||||
Pre-tax income | 3 - 7%* | Please use this template in conjunction with Willis & Adams Materiality Guidelines. The materiality factors provided are guidelines only and should be used only as an aid as you use professional judgment to determine planning materiality. | ||
Total Revenue | 0.5 - 3% | |||
Total Assets | 0.25 - 2% | |||
* For public companies, 5% is typically the maximum. | ||||
Not-for-Profit Entities | ||||
Total Revenue | 0.5 - 3% | |||
Total Assets | 0.25- 2% | |||
Mutual Fund Entities | ||||
Net Asset Value | 3 - 5% | |||
Work Paper 3-8:
EARTHWEAR CLOTHIERS | |||||||||||
Allocation of Materiality: Tolerable Misstatements | |||||||||||
December 31, 2016 | |||||||||||
(In thousands) | |||||||||||
Tolerable Misstatement as % of | |||||||||||
Account Name | 2015 | 2016 Unaudited Trial Balance | Tolerable | Planning Materiality * | Account | Explanation | |||||
Cash and cash equivalents | $ | 48,978 | $ | 79,359 | $ | 1,587 | 50 | % | 2 | % | ? |
Receivables, net | $ | 12,875 | $ | 8,643 | $ | 1,577 | 50 | % | 18 | % | ? |
Inventory | $ | 1,22,337 | $ | 1,47,693 | $ | 2,368 | 75 | % | 2 | % | A large and complex account with misstatements expected, costly to audit |
Prepaid expenses | $ | 17,772 | $ | 15,647 | $ | 1,565 | 50 | % | 10 | % | ? |
Deferred income tax benefits | $ | 7,132 | $ | 10,338 | $ | 2,368 | 75 | % | 23 | % | Relatively complex, estimation involved, related to Deferred Income Taxes |
Property, Plant, & Equipment | $ | 2,06,426 | $ | 2,23,736 | $ | 1,578 | 50 | % | 1 | % | Relatively little change from the prior year, not difficult to audit |
Accumulated depreciation and amortization | $ | 85,986 | $ | 97,722 | $ | 2,368 | 75 | % | 2 | % | ? |
Intangibles, net | $ | 423 | $ | 1,734 | $ | 173 | ?? | % | 10 | % | ? |
Lines of credit | $ | 11,011 | $ | 10,510 | $ | 1,578 | 50 | % | 15 | % | Relatively little volume, not difficult to audit via 3rd party info |
Accounts payable & Reserve for returns | $ | 68,399 | $ | 60,286 | $ | 2,368 | 75 | % | 4 | % | ? |
Accrued liabilities & Accrued profit sharing | $ | 28,270 | $ | 33,600 | $ | 2,368 | 75 | % | 7 | % | ? |
Income taxes payable & Deferred income taxes | $ | 18,057 | $ | 24,567 | $ | 2,368 | 75 | % | 10 | % | ? |
Common stock, 26,121 shares issued | $ | 261 | $ | 261 | $ | 65 | ? | % | 25 | % | No change from the prior year, easily verified |
Donated capital | $ | 5,460 | $ | 5,460 | $ | 1,365 | 43 | % | 25 | % | No change from the prior year, easily verified |
Additional paid-in capital | $ | 20,740 | $ | 25,719 | $ | 1,578 | 50 | % | 6 | % | Little change from the prior year, not difficult to audit |
Deferred compensation | ($ | 79) | ($ | 36) | $ | 0 | ? | % | 0 | % | Not difficult to audit, examine current year vesting activity |
Accumulated other comprehensive income | $ | 3,883 | $ | 2,173 | $ | 543 | ? | % | 25 | % | Involves some complex applications of GAAP |
Retained earnings | $ | 3,17,907 | $ | 3,61,402 | Not Applicable | Not | Not | Not | |||
Treasury stock, 6,546 and 6,706 shares at cost, respectively | ($ | 1,43,950) | ($ | 1,34,512) | $ | 1,578 | 50% | 1 | % | Little change from the prior year, not difficult to audit | |
Total Amount of Tolerable Misstatement Allocated To Balance Sheet Accounts | $ | 25,825 | |||||||||
Planning Materiality (from work paper 3-7) | $ | 3,157 | |||||||||
The ratio of Total Tolerable Misstatement to Planning Materiality *** | 8.2 | ||||||||||
Please fill in the explanation and "?" values
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Authors: Douglas Hoffman, john Bateson
4th edition
1439039399, 978-1439039397
