ACCT 404 Week 3 Group Discussion Board Forum 2 Thread Example

Group Discussion Board Forum 2 Thread: Materiality in Audit Planning

ACCT 404 Assurance and Attestation, Group Discussion Board Forum 2 Thread

Thread by [Student Name]

The manufacturer and its figures are composites; the textbook and the peer-reviewed research cited are real.

Carver Precision Parts, the case for this thread, is a privately held manufacturer with revenues of $96 million, total assets of $70 million and income before taxes of $8.4 million. Its statements are used mainly by its bank, which lends under covenants based on earnings, and by its owners. Both read the statements closely each year. Because users focus on earnings and Carver's income has been stable for several years, pretax income is the most appropriate benchmark. If Carver had been near breakeven, a revenue or total asset benchmark would have produced a more stable threshold, because 5% of a very small income figure would force the team to chase immaterial differences.

Louwers et al. (2018) describe materiality as the amount of misstatement that could reasonably be expected to influence users' decisions. Applying 5% to pretax income gives overall materiality of $420,000. Eilifsen and Messier (2015) reported that the largest firms' materiality guidance is highly consistent in the benchmarks and percentages it uses, with income before taxes the usual benchmark for profitable companies. Performance materiality is set lower to leave room for misstatements the audit does not detect; at 65% of overall materiality, it is $273,000, a moderate figure because Carver has had few audit adjustments in prior years. Misstatements below a clearly trivial threshold of 5% of overall materiality, $21,000, need not be accumulated. Everything above that line goes on the summary of uncorrected misstatements, so that the team can judge their combined effect at the end of the audit rather than one at a time. The summary is reviewed with the engagement partner before the opinion is issued.

Those numbers are necessary, but they are not the whole judgment. A $150,000 overstatement of income is below every threshold, yet it would be material if it moved Carver above a covenant it would otherwise have breached, if it turned a loss into a profit or if it resulted from an intentional act by management. A small error can be material for what it reveals, even when it is immaterial for what it changes. Messier et al. (2005) reviewed two decades of materiality research and found that auditors rely heavily on percentage rules while giving qualitative factors uneven weight, which is why standards and regulators keep reminding auditors that both matter. For Carver, the practical response is to identify the covenant ratios at the planning stage and set a lower materiality for the accounts that drive them, so that the audit is designed around the bank's real decision.

Materiality is ultimately a judgment about people, the banker and owners who will rely on Carver's statements, so the auditor's task is to ask what those users would want to know, not only what a formula allows.

References

Eilifsen, A., & Messier, W. F., Jr. (2015). Materiality guidance of the major public accounting firms. Auditing: A Journal of Practice & Theory, 34(2), 3-26. https://doi.org/10.2308/ajpt-50882

Louwers, T. J., Blay, A. D., Sinason, D. H., Strawser, J. R., & Thibodeau, J. C. (2018). Auditing & assurance services (7th ed.). McGraw-Hill Education.

Messier, W. F., Jr., Martinov-Bennie, N., & Eilifsen, A. (2005). A review and integration of empirical research on materiality: Two decades later. Auditing: A Journal of Practice & Theory, 24(2), 153-187. https://doi.org/10.2308/aud.2005.24.2.153