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.

Materiality Guidelines:

Profit Oriented Entity:

Income Before Income Taxes - combined misstatements or omissions less than 3 percent of Income Before Income Taxes are presumed to be immaterial and combined misstatements or omissions greater than 7 percent are presumed to be material. For publicly traded companies, materiality is typically set at 5 percent of income before income taxes. If pretax income is stable, predictable, and representative[1] of the entitys size and complexity, it is typically the preferred base. However, if net income is not stable, predictable, representative, or if the entity is close to breaking even or experiencing a loss, then other bases may need to be considered. If the entity has volatile earnings, including negative or near zero earnings, it might be more appropriate to use the average of 3 to 5 years of pretax net income as the base (referred to as "normalized earnings").Other possible bases to consider include:

Total Revenue (less returns and discounts) combined misstatements or omissions less than 0.5 percent of Total Revenue are presumed to be immaterial, and combined misstatements or omissions greater than 3 percent are presumed to be material. Total Assets - combined misstatements or omissions less than 0.25 percent of Total Assets are presumed to be immaterial, and combined misstatements or omissions greater than 2 percent are presumed to be material. (Note: Total Assets may not be an appropriate base for service organizations or other organizations that have few operating assets.)

Not-for-Profit Entity

Total Revenue (less returns and discounts) combined misstatements or omissions less than 0.5 percent of Total Revenue are presumed to be immaterial, and combined misstatements or omissions greater than 3 percent are presumed to be material.

Total Assets combined misstatements or omissions less than .25 percent of Total Expenses are presumed to be immaterial, and combined misstatements or omissions greater than 2 percent are presumed to be material.

Mutual Fund Entity

Net Asset Value combined misstatements or omissions less than 3 percent of Net Asset Value are presumed to be immaterial and combined misstatements or omissions greater than 5 percent are presumed to be material.

The specific value within the above ranges for a particular base is determined by considering the primary users as well as qualitative factors. For example, if the client is close to violating the minimum current ratio requirement for a loan agreement, a smaller overall materiality amount should be used. Conversely, if the client is substantially above the minimum current ratio requirement for a loan agreement, it would be reasonable to use a higher overall materiality amount.

Tolerable Misstatement

In addition to establishing overall materiality for the overall financial statements, materiality for individual financial statement accounts should be established. The materiality amount established for individual accounts is referred to as tolerable misstatement. Tolerable misstatement represents the amount an individual financial statement account can differ from its true amount without affecting the fair presentation of the financial statements taken as a whole. Establishment of tolerable misstatement for individual accounts enables the auditor to design and execute an audit strategy for each audit cycle. It is an important input in determining the nature, timing and extent of audit procedures. Tolerable misstatement should be established for all balance sheet accounts (except retained earnings because it is the residual account). Tolerable misstatement need not be allocated to income statement accounts because many misstatements affect both income statement and balance sheet accounts and misstatements affecting only the income statement are normally less relevant to users. The objective in setting tolerable misstatement for individual balance sheet accounts is to provide reasonable assurance that the financial statements taken as a whole are fairly presented in all material respects at the lowest cost. Factors to consider when setting tolerable misstatement for accounts include: -The tolerable misstatement to be allocated to an account is 50 to 75 percent of overall materiality. -Tolerable misstatement should not exceed 25% of the account balance. -Tolerable misstatement should not exceed an amount that would influence the decision of reasonable users. -Tolerable misstatement normally will be higher for accounts with a higher expectation of misstatement. - Total amount of tolerable misstatement allocated to the balance sheet accounts to about ten times materiality in order to limit aggregation risk.

EARTHWEAR CLOTHIERS Planning Materiality December 31, 2016 3-7 30-03-2016 Unaudited 2015 484 $35,757 53.29,959 $1,800 1. Benchmark Data Revenue Pre-tax income Total assets Materiality 19,890 $70,154 3,89,428 2. Establish Plann Pre-tax income Percentage Applied Planning Materiality Level 45% $3,157 Bases and Percentage Ranges: Profit Oriented Entities Pre-tax income Total Revenue Total Assets "For public companies, 5% is typically the maximum. 3-7% 0.5.3% 025.2% 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 us professional judgment to determine planning materiality Not-for-Profit Entities Total Revenue Total Assets 25-296 Mutual Fund Entities 3. Justiy Support Your Level of Planning Materiality State the factors that you considered to determine the appropriate measurement base and percentage to determine planning materiality Measurement Base Percentage