ACCT 404 Week 4 Group Discussion Board Forum 2 Replies Example

Group Discussion Board Forum 2 Replies: Responding on Materiality

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

Thread by [Student Name]

The classmates and their clients are composites; the textbook and the peer-reviewed research cited are real.

Reply to Jacob

Jacob, your thread set materiality for a $40 million distributor at 5% of its $600,000 pretax income, giving $30,000. Your arithmetic is right, but I think the benchmark makes the audit harder without making it better. A threshold of $30,000 for a company with $40 million of revenue means the team would accumulate and evaluate differences that no banker or owner would ever notice, and next year, if income rose to $3 million, materiality would jump fivefold even though the business had barely changed. According to Eilifsen and Messier (2015), the large firms' guidance allows a different benchmark when pretax income is not a stable measure of performance, such as revenue, total assets or an average of several years' income. For your client, 0.5% of revenue would give $200,000, or a three-year average of pretax income might give a figure in the same range. Louwers et al. (2018) emphasize that materiality reflects what users of the statements care about, and for a breakeven distributor the bank is probably watching revenue, margins and working capital more than this year's thin profit. I would keep your qualitative analysis, which was the strongest part of the thread, and change only the base. That combination would let the team focus its effort on the accounts that could actually change a lender's decision. It would also make the threshold more comparable from year to year, which helps the bank read the audit consistently.

Reply to Natalie

Natalie, you concluded that a $30,000 inventory pricing error was immaterial because it fell well below your $500,000 threshold, and quantitatively that is correct. I would ask one more question: why did the error happen? Suppose it occurred because a new cost accountant updated standard costs without anyone reviewing the changes. Then the error is a symptom of a missing review control, and this week's chapter on internal control explains that the auditor must evaluate the deficiency itself, including how large a misstatement it could have allowed, not just the misstatement that happened to occur. If the same unreviewed process covers all $12 million of inventory, the potential misstatement is far larger than $30,000. Doyle et al. (2007) found that material weaknesses in internal control were more likely at companies that were smaller, younger, financially weaker, more complex, growing quickly or restructuring. Your client, which you described as a fast-growing manufacturer that recently added two product lines, fits several of those characteristics. I would recommend communicating the deficiency to management and the audit committee and increasing substantive testing of inventory pricing for the year, even though the error itself can pass as immaterial. That response costs a few extra hours now and could prevent a far larger problem next year. Louwers et al. (2018) describe this kind of response as part of linking the control evaluation to the nature, timing and extent of substantive procedures.

References

Doyle, J., Ge, W., & McVay, S. (2007). Determinants of weaknesses in internal control over financial reporting. Journal of Accounting and Economics, 44(1-2), 193-223. https://doi.org/10.1016/j.jacceco.2006.10.003

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.