Need help with the 3 questions at the end of the text.
Case 12.2 Auto Parts, Inc.: Considering Materiality When Evaluating Accounting Policies and Footnote Disclosures Mark S. Beasley, Frank A. Buckless, Steven M. Glover, Douglas F. Prawitt LEARNING OBJECTIVES After completing and discussing this case, you should be able to . Understand audit and footnote-disclosure issues associated with changes in accounting principles * Develop a reasonable estimate for financial statement materiality and identify qualitative issues that may affect materiality estimates Evaluate the reasonableness of a client's proposed accounting and disclosure preference BACKGROUND Auto Parts, Inc. ("the Company") manufactures automobile subassemblies marketed primarily to the "big three" U.S. automakers. The publicly held Company's unaudited financial statements for the year ended December 31, 2005, reflect total assets of $56 million, total revenues of approximately $73 million, and pre-tax income of $6 million. The Company's audited financial statements for the year ended December 31, 2004, reflected total assets of $47 million, total revenues of approximately $60 million, and pre-tax income of $5 million. Earnings per share have increased steadily over the past five years, with a cumulative return of 140% over that period. During 2005, the Company significantly expanded its plant and fixed asset spending to accommodate increased orders received by its brake valve division. The company also accumulated significant levels of tooling inventory, which primarilyBeasley ,1 Bucklessl' Glover f Prawitt consists of drill bits and machine parts utilized in the manufacturing process. The nature of the tooling inventory is such that the parts wear out relatively quickly and require continual replacement. In prior years, the Company expensed tooling supplies as they Were purchased. However, at the beginning of scal 2005 the controller and chief nancial officer (CFO) determined that capitalization of the tooling inventory would be the preferable method of accounting. The Company changed its accounting policy accordingly and began to include the tooling supplies inventory in \"other current assets\" until the inventory is placed into service, at which time the Company transfers the inventory to expense. During the prior year, 2004, the Company incurred roughly $650,000 of tooling expense and held approximately $175,000 of the inventory on hand at year- end (the onhand inventory was not included in assets on Auto Parts\" balance sheet at December 31, 2005). The unaudited nancial statements for the year-ended December 31, 2005 reect $1,000,000 of tooling expense on the income statement and $300,000 of tooling inventory as current assets on the balance sheet. Given that the $175,000 of inventory onhand at the end of last year was expensed in scal 2005 under the old accounting policy, those costs were not included in the $1,000,000 tooling expense recorded in 2005. Because your accounting rm serves as external auditor for Auto Parts, the CFO and the controller asked your rm for advice on whether the Company would be required to accomt for and disclose the accounting policy change as a change in accounting principle. In the client's opinion, the change is not material to the nancial statements and, therefore, would not require disclosure in the 2005 nancial statements- The client strongly prefers to not make any disclosure related to the policy change. REQUIREMENTS 1. Describe whether you agree that capitalization of the tooling inventory is the preferable method of accounting for Auto Parts. Inn 3. In general, how do auditors develop an estimate of planning materiality? For Auto Parts, Inc., what is your preliminary estimate of nancial statement materiality? Are there qualitative factors that might impact your decision about the materiality of the accounting treatment and the related disclosure? 4. Do you concur with management's assessment that the accounting change is immaterial and, therefore, requires no disclosure? Why or why not
