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.
Screen Shot 2020-0 2 Home Insert Draw Page Layout Formulas Data Review View Tell me to Calibri (Body) 11 ab Wrap Text Genera - A A Paste B I U V V v Merge & Center V A44 fx Significant disclosures required B D E F G 4 Exhibit 4.56.1 5 Dunder.Mifflin, Inc. 6 Unaudited Financial Information Three things that could go wrong Relevant assertion Materiality Current Year (Unaudited) Significant account Inherent risk Y/N H/M/L 9720000 7000000 2720000 2003000 334000 383000 75000 123200 184800 7 8 9 REVENUE AND EXPENSE: 10 Sales (net) 11 Cost of goods sold 12 Gross margin 13 General expense 14 Depreciation 15 Operating income 16 Interest expense 17 Income taxes (40%) 18 Net income 19 20 ASSETS: 21 Cash 22 Accounts receivable 23 Allowance doubtful accounts 24 Inventory 25 Total current assets 26 Fixed assets 27 Accum. depreciation 28 Total assets 29 30 LIABILITIES AND EQUITY: 31 Accounts payable 32 Bank loans, 8% 33 Accrued interest 34 Accruals and other 35 Total current liabilities 36 Long-term debt, 10% 37 Total liabilities 38 Capital stock 39 Retained earnings 40 Total liabilities and equity 690800 900000 -90000 1350000 2850800 4500000 -1834000 5516800 330000 1750000 40000 32000 2152000 400000 2552000 2000000 964800 5516800 42 43 44 Significant disclosures required 45 5 5 6 7 Revenue and expense: Sales (net) Cost of goods sold $9,720,000 7,000,000 ($300,000) (216,000) $9,420,000 6.784,000 Percent Prior Year Current Year $2,720,000 ($84,000) $2,636,000 Change Gross margin General expense Depreciation 2,003,000 334,000 18,000 (4,000) 2,021,000 330,000 4.57 18.4 0.08 85.77 0.4 1.32 -71.02% 30 63.04% 0.1 25.00% 69.43 -19.05% 0.86 115.19% Operating income Interest expense Income taxes (40%) Net income $383,000 75,000 123,200 $184.800 ($98,000) 35,000 (53,200) ($79,800) $285,000 110,000 70,000 $105,000 8 9 Balance Sheet Ratios 10 Current ratio 11 Days' sales in receivables 12 Doubtful accounts ratio 13 Days' sales in inventory 14 Debt/equity ratio 15 Operations Ratios 16 Receivables turnover 10. 17 Inventory turnover 18 Cost of goods sold/sales 19 Gross margin% 20 Return on beginning equity 21 Financial Distress Ratios 22 Working capital/Total assets 23 Retained earnings/Total assets 24 EBIT/Total assets 25 Market value equity/Total debt 26 Net sales/Total assets 27 Discriminant Z Score 28 Market value of equity 29 30 19.57 4.2 69.96% 30.04% 6.62% 58538 26 16 338 12 -38.67% 5.19 23.54% 72.02% 2.95% 27.98% 6.86% 6.37% -3.71% Assets: Cash Accounts receivable Allowance doubtful accounts Inventory Tax receivable $690,800 900,000 (90,000) 1,350,000 SO (300,000) 0 216,000 53,200 $690.800 600,000 (90,000) 1,566,000 53,200 0.49 0.22 0.09 2.59 2.22 4.96 $3,000,000 0.13 -74.29% 0.17 21.11% 0.07 -21.70% 1.18 -54.55% 1.76 -20.52% 3.09 -37.67% $3,000,000 Total current assets Fixed assets Accumulated depreciation $2,850,000 4,500,000 (1,834,000) ($30,800) 0 4,000 $2.820,000 4,500,000 (1,830,000) Total assets $5,516,800 ($26,800) $5,490,000 31 Liabilities and equity: Accounts payable Bank loans, 8% Accrued interest Accruals and other $330,000 1,750,000 40,000 32.000 SO 0 35,000 18,000 $330,000 1,750,000 75,000 50.000 Total current liabilities Long-term debt, 10% $2,152.000 400,000 $53,000 0 32 33 34 34 35 36 36 30 37 o 38 20 39 08 40 41 42 43 $2.205.000 400,000 Total liabilities Capital stock Retained earnings $2,552.000 2,000,000 964,800 $53,000 0 (79,800) $2,605,000 2,000,000 885,000 Total liabilities & equity $5.516.800 (S26,800) $5,490,000 3 Exhibit 4.56.1 4 Dunder-Mifflin, Inc. 5 Unaudited Financial Information Prior Year (Audited) Current Year (unaudited) Change 6 Balance Common Size Balance Common Size Amount Percent Change 7 8 9 10 11 REVENUE AND EXPENSE: Sales (net) Cost of goods sold Gross margin General expense Depreciation Operating income Interest expense Income taxes (40%) Net income $9,000,000 6,296,000 2,704,000 2,044,000 300,000 $360,000 60,000 120,000 $180,000 100.00% $ 9,720,000 69.96 7,000,000 30.04% 2,720,000 22.71 2,003,000 3.33 334,000 4.00% $383,000 0.67 75,000 1.33 123,200 2.00% $184,800 100.00% $ 72.02 27.98% 20.61 3.44 3.94% $ 0.77 1.27 1.90% 720,000 704,000 16,000 (41,000) 34,000 23,000 15,000 3,200 $4,800 8.00% 11.18 0.59% -2.01 11.33 6.39% 25.00 2.67 2.67% 12 13 14 15 16 17 18 19 20 21 22 23 ASSETS: Cash Accounts receivable Allowance doubtful accounts Inventory Total current assets Fixed assets Accum. depreciation Total assets $600,000 500,000 -40,000 1,500,000 $2,560,000 3,000,000 -1,500,000 $4,060,000 14.78% 12.32 -0.99 36.95 63.05% 73.89 -36.95 100.00% $690,800 900,000 -90,000 1,350,000 $2,850,800 4,500,000 -1,834,000 $5,516,800 12.52% 90,800 16.31 400,000 -1.63 (50,000) 24.47 (150,000) 0.5167 $ 290,800 8157.00% 1,500,000 -33.24 (334,000) 100.00% $1,456,800 15.13% 80.00 125.00 -10.00 11.36% 50.00 22.27 35.88% 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 LIABILITIES AND EQUITY: Accounts payable Bank loans, 8% Accrued interest Accruals and other Total current liabilities Long-term debt, 10% Total liabilities Capital stock Retained earnings Total liabilities and equity $450,000 0 60,000 50,000 $560,000 600,000 $1,160,000 2,000,000 900,000 $4,060,000 11.08% 0 1.48 1.23 13.79% 14.78 28.57% 49.26 22.17 100.00% $330,000 1,750,000 40,000 32,000 $2,152,000 400,000 $2,552,000 2,000,000 964,800 $5,516,800 5.98% $ (120,000) -26.67% 31.72 1,750,000 0.73 (20,000) -33.33 0.58 (18,000) -36.00 39.01% $ 1,592,000 284.29% 7.25 (200,000) -33.33 46.26% $ 1,392,000 120.00% 36.25 0.00 17.49 64,800 7.20 100.00% $1,456,800 35.88% 40 24 4. LILTS BERGER & ASSOCIATES, CPAs Ocean City, Florida POLICY STATEMENT Title: Materiality Guidelines --Preliminary Judgment about Materiality and Performance Materiality 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-oriented 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 audit 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 net 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 1 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 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 auditie, 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 + Pages Screen Shot 2020-0 2 Home Insert Draw Page Layout Formulas Data Review View Tell me to Calibri (Body) 11 ab Wrap Text Genera - A A Paste B I U V V v Merge & Center V A44 fx Significant disclosures required B D E F G 4 Exhibit 4.56.1 5 Dunder.Mifflin, Inc. 6 Unaudited Financial Information Three things that could go wrong Relevant assertion Materiality Current Year (Unaudited) Significant account Inherent risk Y/N H/M/L 9720000 7000000 2720000 2003000 334000 383000 75000 123200 184800 7 8 9 REVENUE AND EXPENSE: 10 Sales (net) 11 Cost of goods sold 12 Gross margin 13 General expense 14 Depreciation 15 Operating income 16 Interest expense 17 Income taxes (40%) 18 Net income 19 20 ASSETS: 21 Cash 22 Accounts receivable 23 Allowance doubtful accounts 24 Inventory 25 Total current assets 26 Fixed assets 27 Accum. depreciation 28 Total assets 29 30 LIABILITIES AND EQUITY: 31 Accounts payable 32 Bank loans, 8% 33 Accrued interest 34 Accruals and other 35 Total current liabilities 36 Long-term debt, 10% 37 Total liabilities 38 Capital stock 39 Retained earnings 40 Total liabilities and equity 690800 900000 -90000 1350000 2850800 4500000 -1834000 5516800 330000 1750000 40000 32000 2152000 400000 2552000 2000000 964800 5516800 42 43 44 Significant disclosures required 45 5 5 6 7 Revenue and expense: Sales (net) Cost of goods sold $9,720,000 7,000,000 ($300,000) (216,000) $9,420,000 6.784,000 Percent Prior Year Current Year $2,720,000 ($84,000) $2,636,000 Change Gross margin General expense Depreciation 2,003,000 334,000 18,000 (4,000) 2,021,000 330,000 4.57 18.4 0.08 85.77 0.4 1.32 -71.02% 30 63.04% 0.1 25.00% 69.43 -19.05% 0.86 115.19% Operating income Interest expense Income taxes (40%) Net income $383,000 75,000 123,200 $184.800 ($98,000) 35,000 (53,200) ($79,800) $285,000 110,000 70,000 $105,000 8 9 Balance Sheet Ratios 10 Current ratio 11 Days' sales in receivables 12 Doubtful accounts ratio 13 Days' sales in inventory 14 Debt/equity ratio 15 Operations Ratios 16 Receivables turnover 10. 17 Inventory turnover 18 Cost of goods sold/sales 19 Gross margin% 20 Return on beginning equity 21 Financial Distress Ratios 22 Working capital/Total assets 23 Retained earnings/Total assets 24 EBIT/Total assets 25 Market value equity/Total debt 26 Net sales/Total assets 27 Discriminant Z Score 28 Market value of equity 29 30 19.57 4.2 69.96% 30.04% 6.62% 58538 26 16 338 12 -38.67% 5.19 23.54% 72.02% 2.95% 27.98% 6.86% 6.37% -3.71% Assets: Cash Accounts receivable Allowance doubtful accounts Inventory Tax receivable $690,800 900,000 (90,000) 1,350,000 SO (300,000) 0 216,000 53,200 $690.800 600,000 (90,000) 1,566,000 53,200 0.49 0.22 0.09 2.59 2.22 4.96 $3,000,000 0.13 -74.29% 0.17 21.11% 0.07 -21.70% 1.18 -54.55% 1.76 -20.52% 3.09 -37.67% $3,000,000 Total current assets Fixed assets Accumulated depreciation $2,850,000 4,500,000 (1,834,000) ($30,800) 0 4,000 $2.820,000 4,500,000 (1,830,000) Total assets $5,516,800 ($26,800) $5,490,000 31 Liabilities and equity: Accounts payable Bank loans, 8% Accrued interest Accruals and other $330,000 1,750,000 40,000 32.000 SO 0 35,000 18,000 $330,000 1,750,000 75,000 50.000 Total current liabilities Long-term debt, 10% $2,152.000 400,000 $53,000 0 32 33 34 34 35 36 36 30 37 o 38 20 39 08 40 41 42 43 $2.205.000 400,000 Total liabilities Capital stock Retained earnings $2,552.000 2,000,000 964,800 $53,000 0 (79,800) $2,605,000 2,000,000 885,000 Total liabilities & equity $5.516.800 (S26,800) $5,490,000 3 Exhibit 4.56.1 4 Dunder-Mifflin, Inc. 5 Unaudited Financial Information Prior Year (Audited) Current Year (unaudited) Change 6 Balance Common Size Balance Common Size Amount Percent Change 7 8 9 10 11 REVENUE AND EXPENSE: Sales (net) Cost of goods sold Gross margin General expense Depreciation Operating income Interest expense Income taxes (40%) Net income $9,000,000 6,296,000 2,704,000 2,044,000 300,000 $360,000 60,000 120,000 $180,000 100.00% $ 9,720,000 69.96 7,000,000 30.04% 2,720,000 22.71 2,003,000 3.33 334,000 4.00% $383,000 0.67 75,000 1.33 123,200 2.00% $184,800 100.00% $ 72.02 27.98% 20.61 3.44 3.94% $ 0.77 1.27 1.90% 720,000 704,000 16,000 (41,000) 34,000 23,000 15,000 3,200 $4,800 8.00% 11.18 0.59% -2.01 11.33 6.39% 25.00 2.67 2.67% 12 13 14 15 16 17 18 19 20 21 22 23 ASSETS: Cash Accounts receivable Allowance doubtful accounts Inventory Total current assets Fixed assets Accum. depreciation Total assets $600,000 500,000 -40,000 1,500,000 $2,560,000 3,000,000 -1,500,000 $4,060,000 14.78% 12.32 -0.99 36.95 63.05% 73.89 -36.95 100.00% $690,800 900,000 -90,000 1,350,000 $2,850,800 4,500,000 -1,834,000 $5,516,800 12.52% 90,800 16.31 400,000 -1.63 (50,000) 24.47 (150,000) 0.5167 $ 290,800 8157.00% 1,500,000 -33.24 (334,000) 100.00% $1,456,800 15.13% 80.00 125.00 -10.00 11.36% 50.00 22.27 35.88% 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 LIABILITIES AND EQUITY: Accounts payable Bank loans, 8% Accrued interest Accruals and other Total current liabilities Long-term debt, 10% Total liabilities Capital stock Retained earnings Total liabilities and equity $450,000 0 60,000 50,000 $560,000 600,000 $1,160,000 2,000,000 900,000 $4,060,000 11.08% 0 1.48 1.23 13.79% 14.78 28.57% 49.26 22.17 100.00% $330,000 1,750,000 40,000 32,000 $2,152,000 400,000 $2,552,000 2,000,000 964,800 $5,516,800 5.98% $ (120,000) -26.67% 31.72 1,750,000 0.73 (20,000) -33.33 0.58 (18,000) -36.00 39.01% $ 1,592,000 284.29% 7.25 (200,000) -33.33 46.26% $ 1,392,000 120.00% 36.25 0.00 17.49 64,800 7.20 100.00% $1,456,800 35.88% 40 24 4. LILTS BERGER & ASSOCIATES, CPAs Ocean City, Florida POLICY STATEMENT Title: Materiality Guidelines --Preliminary Judgment about Materiality and Performance Materiality 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-oriented 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 audit 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 net 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 1 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 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 auditie, 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 + Pages
