Your firm, ACTG 307 & Associates, is engaged to audit the financial statements of XYZ Corporation. It is a private manufacturing company that is considering going public in three to four years. Your firm has been preforming audit services to this client for the past five years. The client requires financial statements audits for monitoring purposes, but mainly to receive finance and loans from banks. The management team has high level of competence and integrity, and based on the other teams assessment of internal control, the control risk is low.
Another team did most of the audit tests and completed most of the audit work papers (WP). Your team is assigned to complete the work papers and audit tests of the engagement. Specifically, your team is required to do the following:
- Assess the preliminary materiality based on the policy provided (WP 1-13), and complete WP 3-5, assuming moderate risk and satisfactory results of the analytical procedures.
WP 3-5
XYZ Corp.
Preliminary materiality Judgment
| Measurement base (e.g., income, revenue, assets) | Percentage Applied | Preliminary materiality |
| $ (put the name of the base here) | % | $ (rounded) |
WP 1-13 ACTG 307 & ASSOCIATES, CPAs POLICY STATEMENT Professional judgment is to be used at all times in setting and applying materiality guidelines. As a general guideline, the following policies are to be applied: 1. The combined total of misstatements in the financial statements exceeding 10 percent is normally considered material, less than 5 percent is presumed to be immaterial in the absence of qualitative factors. Between 5 percent and 10 percent require the greatest amount of professional judgment to determine their materiality. 2. The 5 percent to 10 percent must be measured in relation to the appropriate base. Many times there is more than one base to which misstatements should be compared. The following guides are recommended in selecting the appropriate base: a. Income statement. Combined misstatements in the income statement should ordinarily be measured at 5 percent to 10 percent of operating income before taxes. A guideline of 5 percent to 10 percent may be inappropriate in a year in which income is unusually large or small. b. Balance sheet. Combined misstatements in the balance sheet should originally be evaluated for current assets, current liabilities, and total assets. For current assets and current liabilities, the guidelines should be between 5 percent and 10 percent. For total assets, the guidelines should be between 3 percent and 6 percent. 3. Qualitative factors should be carefully evaluated on all audits. XYZ Corporations ANNUAL INCOME STATEMENT ($ Thou: EXCEPT PER SHARE) 12/31/20 12/31/19 12/31/18 21/31/2017 Sales Cost of Goods Sold 152356 123800 155929 131657 155427 130909 152256 132229 28556 24272 24518 20027 Gross Profit Selling, General & Administrative Expense 11530 11756 11910 13593 17026 12516 12608 6434 Operating Income Before Deprec. Depreciation, Depletion & Amortization 7219 6238 5908 5888 546 Operating Profit Interest Expense Non-Operating Income/Expense Special Items 9807 2160 2914 6278 1899 2987 -3120 6700 1130 2297 -409 889 2958 -31310 -2843 Pretax Income Total Income Taxes 7718 -1897 4246 228 7458 2127 -28695 -34831 Income Before Extraordinary Items and Noncontrolling Interests Noncontrolling Interest - Inc Acc 9615 -72 4018 69 5331 -15 6136 -52 Income Before Extraordinary Items & Discontinued Operations Preferred Dividends 3949 9687 0 5346 1576 6188 859 1145 9687 2804 3770 5329 Available for Common Savings Due to Common Stock Equivalents 0 0 0 -470 4859 Adjusted Available for Common Extraordinary Items Discontinued Operations 9687 0 2804 0 3770 0 0 0 0 0 0 9687 2804 3770 4859 Adjusted Net Income Income to Company Incl Extraordinary Items & Disc Ops 9615 4018 5331 6136 6.11 1.75 2.71 3.1 6.11 1.75 2.71 3.1 5.91 1.65 2.38 2.92 Earnings Per Share Basic - Excluding Extra Items & Disc Op Earnings Per Share Basic - Including Extra Items & Disc Op Earnings Per Share Diluted- Excluding Extra Items & Disc Op Earnings Per Share Diluted - Including Extra Items & Disc Op EPS Basic from Operations EPS Diluted from Ops Dividends Per Share Com Shares for Basic EPS Com Shares for Diluted EPS 5.91 5.01 4.87 1.38 1586 1640 1.65 3.06 2.9 1.2 2.38 2.88 2.52 0 1393 1676 2.92 0.23 0.23 0 1566 1675 1605 1687
