You, junior auditor, work for the audit firm Penelopy and Cruz LLP (PC) and you have been assigned to the audit of Frank's Delights (FD), a speciality cake shop. FD was created by Frank Cantanoma over 25 years ago and has thrived in the past with selling speciality cakes for all occasions, from weddings to birthdays. Frank is now getting old and looking to retire. As a result, he has found a potential buyer for the company and has begun preliminary discussions with a potential suitor, Patricia Kemp.

Patricia is new to the specialty cake industry but has several years of pastry school training. She figures that this acquisition will be a quick entry into the market, as Frank has done a great job of marketing FD over the years. Patricia doesn't have much money and is going to be getting a loan from her dad to help her buy the company and as a result, she's looking for the right deal and very cautious about over paying for the company. For acquiring the company, she has expressed wanting to just buy the assets of the company, as she heard from her accountant that this was more beneficial to her when making an acquisition. Patricia approached Frank about purchasing just the assets, but Frank has expressed wanting to sell the shares because his accountant stated that this would be more beneficial to him. As a result, there are still some negotiations ongoing about what the sales transaction would look like. But both Frank and Patricia did agree that they would figure out a deal and figured the next best step would be to have an audit performed to ensure everything is presented fairly for basing a valuation off of.

Patricia has also expressed her concerns over Frank's baking equipment as she is a bit concerned it may be old and out of date, which is also why she wants to purchase the assets instead, as she can pick and choose which assets she wants.

This is where PC was hired by Frank to perform the audit. FD has never been audited in the past, as it does not have any bank debts and has been solely owned by Frank. Frank was always cautious with his year-ends and hired a qualified CPA to perform the bookkeeping.

This is where you, junior auditor, come in. Allan Cruz, one of the partners at PC has assigned you to the FD audit and has asked you to do the preliminary materiality assessment and calculation. He wants to know what materiality levels you recommend, what amounts and why you've selected these amounts.(12 marks)

Below is some select financial information for FD:

Assets

Cash

$25,000

AR

10,000

Inventory

75,000

Equipment

250,000

Furniture

23,000

Total Assets

$383,000

Liabilities

AP

$92,000

Unearned Revenue

17,000

Taxes Payable

11,000

Total Liabilities

120,000

Retained Earnings

263,000

Total Liabs & R/E

$383,000

Income Statement

Revenue

$473,000

COGs

205,000

Gross Profit

268,000

G&A Expenses

39,000

Salaries

112,000

Net Income before tax

$117,000