This is Canadian Auditing (Accounting) !! I am providing sample problem which is to be considered for answering the main question after the sample:

Now, below is the Main question: Handy Hardware Inc. (HHI) is a retailer of tools and home improvement products. HHI is a family owned and operated business, and the founder's grandson Marcus is HHI's newly appointed chief executive officer and chair of the board. HHI has a December 31 year end.

Despite operating in a highly competitive market, HHI has expanded its operations rapidly over the last five years, opening up three retail stores in the past year alone. HHI is an "iconic" brand with a strong reputation for the quality and durability of its products.

In 20X3, HHI implemented a new automated accounting system, AcctPro. While AcctPro resulted in significant efficiencies in inventory management, the new system was installed quickly and without a formal plan. HHI's staff received little training on the new system, and in many instances, they have reverted to manual tracking of accounts in Excel.

In order to finance its expansion, HHI has recently assumed a long-term loan with National Bank. It also has an operating line of credit with the bank. The company has been paying the interest on the operating line but does not have sufficient cash flow to pay down the principal borrowed. Any excess cash flow is being used to make the monthly payments on the long-term bank loan.

Extracts from HHI's financial statements are as follows (in '000s):

Revenue	$7,890
Net income before tax	$4,600
Total assets	$11,700
Accounts receivable	$700
Inventory	$3,875
Accounts payable	$1,025

Additional information:

A $150,000 bonus was paid to HHI's management team in 20X6 for reaching the set revenue target ($7 million in sales). Shareholders have disclosed that they want to be sure that the bonus calculations were accurate, given the company's cash flow position.

During 20X6, HHI sold a warehouse. The gain on the sale of the warehouse totalled $480,000.

HHI has been audited for many years by Hunter Manfield, CPAs. Since 20X3, Hunter Manfield has detected a number of accounting errors resulting from the new accounting system, though HHI has been agreeable to correct most of the errors identified.

It is now January 15, 20X7. You, CPA, work as a manager for Hunter Manfield. You have been tasked with completing the planning for HHI's December 31, 20X6, audit engagement.

Required:

Determine the various materiality levels that should be used for the audit. Your submission should provide responses to each of the steps covered in class notes. "Be sure to provide full explanations and justifications for your choices." Thumbs UP for correct answer !

Materiality Practice Problem Situation: Gothic Kings Ltd. Is a 100% owned subsidiary of Hadrian Inc. Gothic has been profitable in the past but incurred a loss for the year ended December 31, 20X3. Hadrian has indicated that if Gothic incurs another loss, the company will be put up for sale. Gothic is taking several steps to remedy the profit situation, including expanding into new markets which requires new investments. The company has applied to a financial institution for financing for the expansion. The financial institution has indicated it will need audited financial statements before a loan can be approved. It will also require a minimum current ratio of 2:1 You are the new auditor (assume all appropriate client acceptance procedures have been performed and are satisfactory) and you have been provided draft financials containing the following information: Additional information: - A $100,000 bonus was paid to Gothic's management team in 20X3 for reaching a set revenue target ( $2 million in sales). - During 20X3, Gothic sold a warehouse. The loss on the sale of the warehouse totalled $300,000. Required: Determine the various materiality levels that should be used for the audit. Your submission should provide responses to each of the steps covered in class notes. Be sure to provide full explanations and justifications for your choices. Suggested Response: Steps 1 and 2: Identify the users of GK's financial statements and identify their ohiectives GK's users include the bank and the parent company. GK has recently applied for financing so the bank will be primarily concerned with: - Ability to meet the loan principal and interest payments as they come due (profitability and cash flow) and the ability to maintain a minimum current ratio of 2:1 (working capital) GK's parent company are primarily concerned with: - GK's financial health, and whether will it be profitable Step 3: Determine the base for materiality Because GK is a for-profit, privately held company, and both of GK's financial statement users are concerned with profitability, normalized net income before tax will be the basis used for calculating materiality. Step 4: Identify the threshold for materiality PEG recommends a range of 3% to 7% of normalized net income before tax. GK's primary financial statement user, the bank, is evaluating a financing package and are likely to be very sensitive to material misstatement in the base, as it will use GK's financial statements to monitor the company's financial health and its compliance with the debt covenant imposed. The parent company has indicated that profitability is a must so are also likely to be very sensitive to errors in the base. Given both users' sensitivity to material misstatement, 3% of normalized net income has been chosen for the calculation of overall materiality. Step 5: Determine overall materiality There are two items that must be considered in the calculation of materiality, as they are considered to be unusual or non-recurring: the $100,000 bonus paid to GK's management team in 20X6 and the $300,000 loss on the sale of GK's warehouse. Normalizing calculation: Normalizing calculation: Based on the calculation above and the reliance of the users on net income, overall materiality shall be set at $7,000. Step 6: Determine PM A percentage of 60% of overall materiality will be chosen for the calculation of PM. A percentage in the lower range is chosen given the fact that there are number of audit risk factors that will increase the overall audit risk. These are 1) GK has been put on notice by the parent that they must be profitable, increasing the risk that management may be motivated to try and overstate profitability to satisfy the parent's expectations, 2) there is a bonus scheme for management that may motivate an overstate of earnings to maximize bonus payouts, 3) GK is looking for financing and will need to provide financial results to support their application, leading to a possibility of overstating results. All factors, therefore, increase the possibility of material misstatements. PM=$4,200($7,00060%=$4,200roundeddown)