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 Planning Materiality December 31, 2016 (In thousands)				3-7 30-03-2016
		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 Misstatement		Planning Materiality *		Account Balance **		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 Applicable		Not Applicable		Not Applicable
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