Using your preliminary analytics for Problem 4.56, identify each significant account and disclosure.

Using Exhibit 4.12 as a guide, for each significant identified in #1 above, list three things that could go wrong for that account.

Using 4.12 as a guide, for each of the three things that you list for each significant account, indicate the relevant assertion.

Assuming that the audit risk is high for this client, calculate performance materiality and allocate this materiality to each balance sheet account except retained earnings. Use the guidelines in the policy statement for Lilts Berger & Associates on Page 6 of the Oceanview booklet.

4 LILTS BERGER & ASSOCIATES, CPAS Ocean City, Florida POLICY STATEMENT Materiality Title: Materiality Guidelines-Preliminary Judgment about Materiality and Performance Preliminary Judgment about Materiality Professional judgment is to be used at all times in setting and applying materiality guidelines. Materiality must be measured in relation to the appropriate base. As a general guideline, the following policies are to be applied 1. For profit-cronted companies, the appropriate materiality base will be pre-tax income. The preliminary judgment about materiality should ordinarily be measured between 5 and 10% of net income before taxes for private companies. A combined total of misstatements or omissions in the financial statements exceeding 10% is normally considered material, A combined total of less than 5%% is presumed to be immaterial in the absence of qualitative factors. Combined misstatements or omissions between 5 and 10% require the greatest amount of professional judgment to determine their materiality Acceptable audit risk is a major consideration in the decision. When acceptable audi risk is low, the preliminary judgment about materiality would typically be 5 to 6% of pre-tax income. When acceptable audit risk is high, the preliminary judgment about materiality would be 9 to 10% of pre-tax income. If not income before taxes in a given year is not considered representative (unusually high, low, or negative), it would be desirable to use a different base such as total assets (see 2 below). 2. Often there is more than one base to which misstatements could be compared. Normalized pre-tax income may not be an appropriate base for not-for-profit enterprises. Also, if a company operates in an industry where size is more relevant than operations or where net income before taxes is unusually low or high for the size of the company the preliminary judgment about materiality should be measured using either balance sheet or income statement amounts as a base. Even if the preliminary judgment about materiality is based on pretax income, a balance sheet-based calculation is useful for evaluating the materiality of misclassifications between balance sheet accounts. For total assets, the guidelines should be between Is and 1% of assets. 3 Qualitative factors should be carefully evaluated in the final evaluation of materiality on all audits. In many instances, they are more important than the guidelines applied to the income statement and balance sheet. The intended uses of the financial statements and the nature of the information in the statements, including footnotes, must be carefully evaluated. Performance Materiality Professional judgment is to be used in setting and applying performance materiality. As a general guideline, the following policies are to be applied: 1. Performance materiality will be established only for balance sheet accounts. 2. Performance materiality will be established for every balance sheet account except retained earnings. 3. The maximum performance materiality to be applied to any account is 75% of the preliminary judgment about materiality 4. The combined performance materiality for all accounts shall not exceed three times the preliminary judgment about materiality 5. The following are major factors affecting the setting of performance materiality for individual balance sheet accounts: . Performance materiality should be set higher for accounts with a high cost to audit (Le., larger accounts, and accounts that are relatively difficult to audit). Performance materiality, as a percent of the account balance, should be set higher for accounts with a higher expectation of misstatement. Assignment THREE + Page sO Screen Shot 2020- rhi Home Insert Draw Page Layout Formulas Data Review View Tell me X Calibri (Body) 11 A A ab Wrap Text ~ Gener Paste B I U Y AVAv Merge & Center v $ A44 X V fx Significant disclosures required A B C D E F G Exhibit 4.56.1 5 Dunder-Mifflin, Inc. 6 Unaudited Financial Information Three things that Current Year Significant account Inherent risk could go wrong Relevant assertion Materiality (Unaudited] Y/N H/M/L REVENUE AND EXPENSE: 10 Sales (net) 9720000 Cost of goods sold 7000000 12 Gross margin 2720000 13 General expense 2003000 14 Depreciation 334000 15 Operating income 383000 16 Interest expense 75000 17 Income taxes (40%%) 123200 18 Net income 184800 20 ASSETS 21 Cash 690800 22 Accounts receivable 900000 Allowance doubtful accounts -90000 Inventory 1350000 25 Total current assets 2850800 26 Fixed assets 4500000 27 Accum. depreciation 1834000 28 Total assets 5516800 30 LIABILITIES AND EQUITY: Accounts payable 330000 32 Bank loans, 8% 1750000 33 Accrued interest 40000 34 Accruals and other 32000 35 Total current liabilities 2152000 36 Long-term debt, 10% 400000 Total liabilities 2552000 Capital stock 2000000 39 Retained earnings 964800 Total liabilities and equity 5516800 44 Significant disclosures required 45Revenue and expense: Sales (net) $9,720,000 ($300,000) $9,420,000 Cost of goods sold 7,000,000 (216,000) 6,784,000 Prior Year Current Percent Gross margin $2,720,000 ($84,000) $2,636,000 B Year Change Balance Sheet Ratios General expense 2,003,000 18,000 2,021,000 10 Current ratio 4.57 1.32 -71.02% Depreciation 334,000 (4,000) 330,000 11 Days' sales in receivables 18.4 30 63.04% 12 Doubtful accounts ratio 0.08 0.1 25.00% Operating income $383,000 ($98,000) $285,000 13 Days' sales in inventory 85.77 69.43 -19.05% Interest expense 75,000 35,000 110,000 14 Debt/equity ratio 0.4 0.86 115.19% Income taxes (40%) 123,200 (53,200) 70,000 15 Operations Ratios Net income $184,800 ($79,800) $105,000 Receivables turnover 19.57 12 -38.67% 17 Inventory turnover 4.2 5.19 23.54% Assets: 18 Cost of goods sold/sales 69.96% 72.02% 2.95% Cash $690,800 50 $690,800 19 Gross margin % 30.04% 27.98% -6.86% Accounts receivable 900,000 (300,000) 600,000 20 Return on beginning equity 6.62% 6.37% -3.71% Allowance doubtful accounts (90,000) 0 (90,000) 21 Financial Distress Ratios Inventory 1,350,000 216,000 1,566,000 22 Working capital Total assets 0.49 0.13 -74.29% Tax receivable 53,200 53.200 23 Retained earnings/Total assets 0.22 0.17 -21.11% 24 EBIT/Total assets 0.09 0.07 -21.70% Total current assets $2,850,000 ($30,800) $2,820,000 25 Market value equity/Total debt 2.59 1.18 -54.55% Fixed assets 4,500,000 4,500,000 26 Net sales/Total assets 2.22 1.76 -20.52% Accumulated depreciation (1,834,000) 4,000 (1,830,000) 27 Discriminant Z Score 4.96 3.09 -37.67% 28 Market value of equity $3,000,000 $3,000,000 Total assets $5,516,800 ($26,800) $5,490,000 29 30 Liabilities and equity: 31 Accounts payable $330,000 $330,000 32 Bank loans, 8% 1,750,000 1,750,000 33 Accrued interest 40.000 35,000 75,000 34 Accruals and other 32,000 18,000 50,000 35 36 Total current liabilities $2,152,000 $53,000 $2,205,000 37 Long-term debt, 10% 400,000 400,000 38 39 Total liabilities $2,552,000 $53,000 $2,605,000 40 Capital stock 2,000,000 2,000,000 Retained earnings 964,800 (79,800) 885,000 43 Total liabilities & equity $5,516,800 ($26,800) $5,490,0003 Exhibit 4.56.1 Dunder-Mifflin, Inc. 5 Unaudited Financial Information Prior Year (Audited) Current Year (unaudited) Change Balance Common Balance Common Amount Percent Size Size Change REVENUE AND EXPENSE: Sales (net) $9,000,000 100.00% $ 9,720,000 100.00% $ 720,000 8.00% 10 Cost of goods sold 6,296,000 69.96 7,000,000 72.02 704,000 11.18 Gross margin 2,704,000 30.04% 2,720,000 27.98% 16,000 0.59% 12 General expense 2,044,000 22.71 2,003,000 20.61 (41,000) -2.01 13 Depreciation 300,000 3.33 334,000 3.44 34,000 11.33 14 Operating income $360,000 4.00% $383,000 3.94% $ 23,000 6.39% 15 Interest expense 60,000 0.67 75,000 0.77 15.000 25.00 16 Income taxes (40%) 120,000 1.33 123,200 1.27 3.200 2.67 17 Net income $180,000 2.00% $184,800 1.90% $4,800 2.67% 18 19 ASSETS: 20 Cash $600,000 14.78% $690,800 12.52% 90,800 15.13% 21 Accounts receivable 500,000 12.32 900,000 16.31 400,000 80.00 22 Allowance doubtful accounts -40,000 -0.99 -90,000 -1.63 (50,000) 125.00 23 Inventory 1,500,000 36.95 1,350,000 24.47 (150,000) -10.00 24 Total current assets $2,560,000 63.05% $2,850,800 0.5167 $ 290,800 11.36% 25 Fixed assets 3,000,000 73.89 4,500,000 8157.00% 1,500,000 50.00 26 Accum. depreciation 1,500,000 -36.95 -1,834,000 -33.24 334,000) 22.27 27 Total assets $4,060,000 ).00% $5,516,800 100.00% $1,456,800 35.88% 26 29 LIABILITIES AND EQUITY: 30 Accounts payable $450,000 11.08% $330,000 5.98% $ (120,000) -26.67% 31 Bank loans, 8% 1,750,000 31.72 1,750,000 32 Accrued interest 60,000 1.48 40,000 0.73 (20,000) -33.33 33 Accruals and other 50,000 1.23 32,000 0.58 (18,000) -36.00 34 Total current liabilities $560,000 13.79% $2,152,000 39.01% 1,592,000 284.29% 35 Long-term debt, 10% 600,000 14.78 400,000 7.25 (200,000) -33.33 36 Total liabilities $1,160,000 28.57% $2,552,000 46.26% $ 1,392,000 120.00% 37 Capital stock 2,000,000 49.26 2,000,000 36.25 0.00 38 Retained earnings 900,000 22.17 964,800 17.49 64,800 7.20 39 Total liabilities and equity $4,060,000 100.00% $5,516,800 100.00% $1,456,800 35.88% 40