This case is to be used in conjunction with the facts in Problem 10-47 and can be completed individually or in groups via classroom discussion.
Part 1.Without regards to the dollar amount of the calculated upper misstatement limit for accounts receivable in Problem 10-47, assume that you have calculated that the upper misstatement limit is $213,500, and assume that the test of details risk is 10%. Recall that materiality for this engagement is set at $215,000.
What is the implication of the fact that the most likely misstatement is very close to the materiality threshold? What does the closeness of these dollar amounts imply with regard to whether the accounts receivable amount requires downward adjustment? Using the ethical decision-making framework (which is based on Utilitarian Theory and Rights Theory from Chapter 3), develop an appropriate course of action to take assuming the following possibilities:
a. You think that the accounts receivable balance is fairly stated because the misstatement is below the materiality threshold, but you are not entirely convinced of the soundness of your judgment given the nearly material amount of the upper misstatement limit.
b. You collect a larger sample size. You send out ten more accounts receivable confirmations, and find two more overstatements totaling $88,000.Your senior tells you that the client has agreed to write down those two specific accounts receivables. He says that because of this agreement, you should disregard these overstatements for purposes of making a conclusion about the accounts receivable balance in total.
Part 2.Without regard to the dollar amount of the most likely misstatement and the upper misstatement limit for accounts receivable in Problem 10-47, assume that the most likely misstatement is $230,000, and assume that the test of details risk is 10%. Recall that materiality for this engagement is set at
$215,000.Your senior tells you that he has decided to increase the materiality amount to $250,000. His rationale for this change is that the client is in good financial health and has relatively strong internal controls. What is the implication of the change in materiality amount with regard to whether the accounts receivable amount requires downward adjustment? Using the ethical decision-making framework (which is based on Utilitarian Theory and Rights Theory from Chapter 3), develop an appropriate course of action to address this situation.
Part 3. As noted in Problem 10-47, the sample of accounts receivable that you collected revealed five audit differences. For nearly all of those cases, the book value was greater than the audited value. What is management's incentive with regard to potential misreporting associated with accounts receivable (or other assets)? Assume that this pattern of overstatements has become routine during the past several years on this engagement. What does this trend potentially reveal about management? What are the ethical implications of this trend? What should you do?