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Why is it necessary to compare unadjusted misstatements to other bases of materiality, and what should an auditor do if the unadjusted misstatements exceed one or more materiality thresholds?

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Casey Durgan
Casey DurganLv2
28 Sep 2019
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What is materiality? Is materiality measured the same wayacross different authoritative bodies? What factors would you useon an audit to determine materiality? Can you give an example whentwo auditors do not agree on an issue that may or not be materialand how would you as a third auditor resolve it?

Panzero Bread is a major retailer of specialty sandwich itemsand baked goods. The following information represents the com-pany’s financial position as of 12/31/14 and 12/31/13. 12/31/14(unaudited) 12/31/13 (audited) Total assets $698,752,000$542,609,000 Accounts receivable $25,152,000 $19,041,000 Totalsales $1,066,691,000 $828,971,000 Cost of goods sold $842,255,000$628,534,000 Net income $57,456,000 $58,849,000 Earnings per share$1.81 $1.88 The auditor of Panzero Bread identifies the company asa client with high audit risk and has set the posting thresholdsfor individ- ual accounts at 10% of overall financial statementmateriality levels. The auditors have detected an overstatement ofaccounts receivable of $345,000. The misstatement is not a surpriseto the auditors, as they have detected misstatements in thisaccount in the past. On a per share basis, the misstatementrepresents $0.01 of earnings per share. The auditor believes thatthe misstatement should be corrected. Management argues stronglythat they prefer not to make the correction because they do notbelieve it is mate- rial; that is, the misstatement represents justover 1% of the account balance. Although left unsaid, the auditorknows that management is under considerable pressure from WallStreet to meet analyst expectations for earnings per share.Reducing earnings per share by even $0.01 would cause the trend inearnings to become even more negative than the unaudited financialnumbers already reveal, and it would cause the company to just missanalyst forecasts for earnings per share. a. Use the three commonbenchmarks for making materiality judgments (net income, totalassets, and net sales) to establish materiality for the financialstatements overall. b. What difficulties does the auditor face whenthe alternative benchmarks yield differing conclusions aboutmateriality? What qualitative factors should the auditor considerin making its materiality judgment in that case? c. Articulate areason for choosing one particular benchmark among the threecalculated in part (a), and use that benchmark to calculate theposting (clearly trivial) threshold for the accounts receivableaccount. d. What effect will the qualitative factors in this casehave on the auditor’s posting (clearly trivial) threshold for theaccounts receivable account?

An auditor finds three misstatements.For each misstatement,categorize it as factual, judgmental, projected, error, orfraudulent.The misstatements may or may not belong to more than onecategory. Include only the categories supported by the descriptionof the misstatement. Misstatement 1:An auditor samples accountsreceivable and finds a total of $3,000 overstatements in thesample. Based on the sample in misstatement 1, the auditor believesthat accounts receivable is overstated by a total of $30,000. Aclient records bad debt at 2% of sales, the same as last year. Theauditor thinks it should be recorded at 4% because of changedeconomic conditions.

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