Graded Audit Task \#1 Consolidated Construction Inc., an issuer, is a construction company with annual revenues of $20 million. As the audit senior engaged on Consolidated Construction's Year 6 financial audit, you have been asked to calculate materiality as the engagement team plans the audit. Using the exhibits, perform a quantitative and qualitative analysis. In Part 1 , determine overall materiality. In column B, calculate and enter the current ratio rounded to two decimal places. In column C, select the calculation approach the auditor should use. In column D, calculate and enter audit materiality. In Part II, perform a qualitative analysis and identify areas of qualitative concern for the Year 6 audit. There are four areas of qualitative concern. Consolidated Construction Inc. Balance Sheet Consolidated Construction Inc. Income Statement For the Years Ending December 31, Years 6 and 5 Excerpts From Audit Firm's Internal Guidance - Handbook for Engagement Teams Quantitative Materiality Analysis The audit firm's standard methodology to determine overall materiality for an engagement is based on a percentage of income before taxes for the current year. If the client reports a loss or has a poor liquidity ratio (i.e., a current ratio of 1.19 or lower), overall materiality should instead be based on a percentage of total assets. Standard percentages to use in determining overall materiality are: - 5 percent of income before taxes - 2 percent of total assets Qualitative Analysis In planning the audit, the engagement team must consider whether any of the following factors exist with respect to the audit engagement or the client. Any such factors identified must be documented in the audit file, and the percentage for tolerable misstatement adjusted accordingly: - Overall engagement risk is considered high (e.g , client operates in a high-risk industry, there are unusually high market pressures with respect to client, first-year audit engagement, engagement relates to special purpose financial statements) - Fraud risk is high (e.g., internal or external pressures, ineffective governance controls, inexperienced or incompetent accounting personnel, contentious relationship with client, evasive responses to audit inquiries) - History of identifled misstatements in prior year audits - History of material weaknesses, significant deficiencies, and/or a high number of deficiencies in internal control - High risk of misstatement related to specific account balances, classes of transactions, or disciosures - Increased or higher-than-usual number of accounting issues that require significant judgment. and/or greater use of estimates with inherent uncertainty or subjectivity - High turnover in senior management, accounting, or financial reporting personnel - Cient operates in multiple locations (locations may consist of office/operational space or project locations) Exhibit 4: Company and Industry Information As part of its engagement assessment and planning procedures, the audit engagement team noted the following information regarding the client and the industry in which it operates: - Consolidated Construction Inc. performs work as a general contractor in the state of Pennsylvania. - The company is structured as a C-corporation. - Consolidated Construction Inc. is publicly traded and, therefore, is required to have an annual audit performed. Consolidated Construction's total revenue has exceeded $20 million for the past three years. Projections indicate that revenue will continue to increase during the current fiscal year. - While demand for new construction has recently increased, the industry has experienced skilled labor shortages. - Fixed-bid contracts significantly increased for Consolidated Construction during Year 6 , affecting total sales. There is an increased need for more accurate bid estimating in order to reduce the risk of cost overruns on projects. Exhibit 5: Qualitative Analysis As part of its qualitative analysis for the purposes of determining materiality and tolerable misstatement, the audit engagement team noted the following with respect to the engagement, the client, and the industry in which the client operates: - While changes have taken place in the construction industry during the past year, such changes were not considered significant enough to increase overall engagement risk. - Fraud risk is considered to be low. - Management is open and transparent regarding the company's operations and is generally supportive of the audit process. - Per review of prior years' audit workpapers, there is no history of material identified misstatements, material weaknesses, or significant control deficiencies. - As part of the company's ccy inuous improvement efforts, management has indicated that they have made several enhancetnents to their internal control over financial reporting during the current year. Management asserts that these controls are performing effectively. - The company's chief financial officer (CFO) resigned in July of Year 6. Shortly after, in August of Year 6 , the accounting director also left the company when she was not offered the CFO position. - The company currently has seven different multimillion-dollar construction projects in progress at various construction sites, all located within a 50-mile radius of the company's main office. - The company's current contracts with customers - both private and government-are all currently fixed-bid contracts. This represents a significant shift from prior years, when a large portion of the company's contract portfolio was structured differently (e.g., cost-plus pricing). This change in contract pricing and terms has increased the company's reliance on projections and estimates, because revenue recognition for such contracts involves a greater use of estimation and judgment (such as for cost basis, rework and uninstalled materials adjustments, when determining delivery of performance obligations over time). Therefore, the audit engagement team has assessed a higher-than-normal level of risk of potential misstatement for related account balances and transactions (i.e., accounts receivable and revenue). Graded Audit Task \#1 Consolidated Construction Inc., an issuer, is a construction company with annual revenues of $20 million. As the audit senior engaged on Consolidated Construction's Year 6 financial audit, you have been asked to calculate materiality as the engagement team plans the audit. Using the exhibits, perform a quantitative and qualitative analysis. In Part 1 , determine overall materiality. In column B, calculate and enter the current ratio rounded to two decimal places. In column C, select the calculation approach the auditor should use. In column D, calculate and enter audit materiality. In Part II, perform a qualitative analysis and identify areas of qualitative concern for the Year 6 audit. There are four areas of qualitative concern. Consolidated Construction Inc. Balance Sheet Consolidated Construction Inc. Income Statement For the Years Ending December 31, Years 6 and 5 Excerpts From Audit Firm's Internal Guidance - Handbook for Engagement Teams Quantitative Materiality Analysis The audit firm's standard methodology to determine overall materiality for an engagement is based on a percentage of income before taxes for the current year. If the client reports a loss or has a poor liquidity ratio (i.e., a current ratio of 1.19 or lower), overall materiality should instead be based on a percentage of total assets. Standard percentages to use in determining overall materiality are: - 5 percent of income before taxes - 2 percent of total assets Qualitative Analysis In planning the audit, the engagement team must consider whether any of the following factors exist with respect to the audit engagement or the client. Any such factors identified must be documented in the audit file, and the percentage for tolerable misstatement adjusted accordingly: - Overall engagement risk is considered high (e.g , client operates in a high-risk industry, there are unusually high market pressures with respect to client, first-year audit engagement, engagement relates to special purpose financial statements) - Fraud risk is high (e.g., internal or external pressures, ineffective governance controls, inexperienced or incompetent accounting personnel, contentious relationship with client, evasive responses to audit inquiries) - History of identifled misstatements in prior year audits - History of material weaknesses, significant deficiencies, and/or a high number of deficiencies in internal control - High risk of misstatement related to specific account balances, classes of transactions, or disciosures - Increased or higher-than-usual number of accounting issues that require significant judgment. and/or greater use of estimates with inherent uncertainty or subjectivity - High turnover in senior management, accounting, or financial reporting personnel - Cient operates in multiple locations (locations may consist of office/operational space or project locations) Exhibit 4: Company and Industry Information As part of its engagement assessment and planning procedures, the audit engagement team noted the following information regarding the client and the industry in which it operates: - Consolidated Construction Inc. performs work as a general contractor in the state of Pennsylvania. - The company is structured as a C-corporation. - Consolidated Construction Inc. is publicly traded and, therefore, is required to have an annual audit performed. Consolidated Construction's total revenue has exceeded $20 million for the past three years. Projections indicate that revenue will continue to increase during the current fiscal year. - While demand for new construction has recently increased, the industry has experienced skilled labor shortages. - Fixed-bid contracts significantly increased for Consolidated Construction during Year 6 , affecting total sales. There is an increased need for more accurate bid estimating in order to reduce the risk of cost overruns on projects. Exhibit 5: Qualitative Analysis As part of its qualitative analysis for the purposes of determining materiality and tolerable misstatement, the audit engagement team noted the following with respect to the engagement, the client, and the industry in which the client operates: - While changes have taken place in the construction industry during the past year, such changes were not considered significant enough to increase overall engagement risk. - Fraud risk is considered to be low. - Management is open and transparent regarding the company's operations and is generally supportive of the audit process. - Per review of prior years' audit workpapers, there is no history of material identified misstatements, material weaknesses, or significant control deficiencies. - As part of the company's ccy inuous improvement efforts, management has indicated that they have made several enhancetnents to their internal control over financial reporting during the current year. Management asserts that these controls are performing effectively. - The company's chief financial officer (CFO) resigned in July of Year 6. Shortly after, in August of Year 6 , the accounting director also left the company when she was not offered the CFO position. - The company currently has seven different multimillion-dollar construction projects in progress at various construction sites, all located within a 50-mile radius of the company's main office. - The company's current contracts with customers - both private and government-are all currently fixed-bid contracts. This represents a significant shift from prior years, when a large portion of the company's contract portfolio was structured differently (e.g., cost-plus pricing). This change in contract pricing and terms has increased the company's reliance on projections and estimates, because revenue recognition for such contracts involves a greater use of estimation and judgment (such as for cost basis, rework and uninstalled materials adjustments, when determining delivery of performance obligations over time). Therefore, the audit engagement team has assessed a higher-than-normal level of risk of potential misstatement for related account balances and transactions (i.e., accounts receivable and revenue)