Auditing Individual Project 2

Spring 2021

Kendrick Lamar, CPA was conducting the audit of J. Cole, Inc. for the year ended December 31, 2020. Kendrick evaluated the accounts receivable of J. Cole and determined that there is a 95% probability that the true population misstatement is less than or equal to $220,694. Kendrick decided that he should conclude that accounts receivable is not materially misstated, since the upper misstatement limit of $220,694 is less than the tolerable misstatement of $250,000. Kendrick also concluded that no other accounts in J. Coles financial statements were materially misstated, so he was planning to issue an unqualified audit opinion.

However, one of Kendricks coworkers mentioned that he should probably review SEC Staff Accounting Bulletin 108 before issuing the audit report. After reading the bulletin, Kendrick decided that he needed to consider the misstatements in J. Coles financial statements over the past several years and, consequently, constructed the following table to better help him analyze the situation. The table shows uncorrected, immaterial misstatements from years 2014 2019 and how they would have impacted the financial statements of those years, if corrected (e.g., net income in 2014 was overstated by $523,171 and would have been reduced by this amount if the 2014 misstatements had been corrected).

Year			Effect on Net Income		Effect on Assets		Effect on Liabilities		Effect on Equity
	2014	(523,171)		(1,743,902)		(1,220,731)		(523,171)
	2015	(831,687)		(2,376,248)		(1,544,561)		(831,687)
	2016	(473,803)		(1,579,342)		(1,105,539)		(473,803)
	2017	(1,167,225)		(3,071,644)		(1,904,419)		(1,167,225)
	2018	796,208		2,274,881		1,478,673		796,208
	2019	(572,581)		(1,908,603)		(1,336,022)		(572,581)

Kendrick has identified several misstatements in the 2020 financial statements, none of which exceed planning materiality of $3,000,000. The impacts of the 2020 misstatements on the 2020 financial statements, if corrected, are:

Net Income $ (333,918)

Assets $ (1,335,672)

Liabilities $ (1,001,754)

Equity $ (333,918)

Required:

1. Evaluate the materiality of the uncorrected misstatements on J. Coles financial statements using (a) the rollover method and (b) the iron curtain method, making sure to identify the $ amount of the misstatement to consider under each method. Do not give more than one $ amount as your answer for either 1(a) or 1(b).
2. Given your results in part 1, should Kendrick conclude that the financial statements are materially misstated? Why or why not?
3. Refer to SEC Staff Bulletin 108. What is the primary weakness of the rollover method? What is the primary weakness of the iron curtain method? Why does the SEC recommend using both methods when evaluating financial statement misstatements?