Question

^{Hello - Can you please assist with this question:}

Amazon has experienced tremendous sales growth over the last decade and it turned its first profit in 2015. It has remained profitable in to 2017 as it earned a profit before tax of $4 billion on sales of $178 billion for the year ended December 31, 2017. Its asset balance as of December 31, 2017 is $131 billion.  

For the 2017 audit, please use your professional judgment to select the best measure for calculating materiality (sales, profit before tax, or total assets) for Amazon's financial statements. Explain your rationale for the measure you select. Finally, calculate the materiality threshold for the 2017 Amazon audit.   

As a bonus question, what other financial measures (beyond sales, profit before tax and assets) would you consider in setting the materiality threshold for Amazon?

Answer 1

The best measure to calculate materiality for Amazon for the year 2017 should be a percentage of Revenues. Mostly we use net income as base in auditing is net income and commonly percentages are in the range of 5 – 10 percent (for example an amount <5% = immaterial, > 10% material and 5-10% requires judgment). However, with reference to Amazon, I would like to have a more conservative approach and lower percentages should be applied in this case due to high staff turnover and operations in various locations (multinational). When profit before tax from continuing operations is volatile, other benchmarks such as total revenues (sales) may be more appropriate to use (1 – 2 percent of total revenue). Moreover Revenue is the driving factor for the business and due to the scale of business, Revenue should be used to calculate materiality (0.2-1.5%)

In this case, materiality should be 0.5 % of $178 billion (sales) i.e. $ 0.89 billion.

Other Financial measures that can be used are as follows:

• profit before tax or normalised (or adjusted) profit before tax

• total income or total expenses

• gross profit

• total equity

• net assets.

• EBITDA