Holiday Cruises Company Case Study: The external auditing standards require the auditor to obtain an understanding of controls that are relevant to the audit process and assess whether they are sufficiently designed to prevent or detect material misstatements that might be made in the financial statements. Then the auditor is also required to test whether these controls have been implemented and work effectively to prevent or detect such material misstatements. Furthermore, the auditing standards require auditors to identify where and how the financial statements may possibly carry a higher risk of being materially misstated. The auditor uses that understanding to help design what further audit procedures might be effective in detecting any material misstatement that may exist. Given the above, you have been selected as a member of the audit team responsible for auditing the financial statements of Holiday Cruises, a company operating leisure cruises since a few years ago from ports on the Arabian Gulf and North Africa. Holiday Cruises sells cruises bookings to individuals and travel agents. The majority of these sales transactions are mainly conducted via its website and some using traditionally sales offices located in the main cities. All cruises are paid in advance, with a 10% deposit on booking and the remainder collected at least four weeks before sailing. Travel agents collect money from their customers, deduct their commissions and forward the remainder to the cruise company before the deadline. Holiday Cruises company provides additional discounts for large groups bookings, and these discounts are solely identified and approved by Mr Talal, the supervisor for large group bookings. The audit team has made a preliminary assessment that the client has low control risk over sales transactions and the accounts receivable and plans to conduct supporting extensive testing of controls over sales and accounts 3 receivable areas to support this assessment. The preliminary assessment of controls over operations revealed that the operations supervisor employs new casual (temporary) staff to do the catering and other supporting work whenever seasonal demand increases. He sets their hourly pay rate based on his assessment of their experience. He asks new staff to write their bank account details on their first timesheet to transfer the wages payments to them electronically. At the end of the day, he collects timesheets (which are not sequentially numbered) from each casual employee and hands them to the payroll officer. For some casual employees, English is not their first language, so the supervisor regularly needs to adjust the timesheets before giving them to the payroll officer to ensure they are correct.

required:

Assuming that the criteria that your audit team shall rely on to determine the overall materiality level is 5% of the companys turnover (sales revenue) that amounts $1,500,000, you are required to calculate the two levels of materiality; overall level and the level for the operating expenses account; given that your test of internal controls that this account (Operating expenses) is highly material and 60% of the overall misstatements will be allocated to this account. In addition, you are required to explain the meaning of these materiality levels and how they can be used in the reporting stage.