Question

Scenario 1:
Murphy & Johnson is a privately owned manufacturer of small motors for lawnmowers, tractors, and snowmobiles. The components of its financial statements are (1) income before taxes = $21 million, (2) total assets = $550 million, and (3) total revenues = $775 million. Murphy & Johnson's CPA firm uses the normal percentage for income before taxes for a public company for determining overall materiality.

a. Determine overall materiality, and determine tolerable misstatement. Explain your answer.

b. During the course of the audit, Murphy & Johnson’s CPA firm detected two misstatements that aggregated to an overstatement of income of $1.25 million. Evaluate the audit findings. Explain your answer.

Scenario 2:

Delta Investments provides a group of mutual funds for investors. The components of its financial statements are (1) income before taxes = $40 million, (2) total assets = $4.3 billion, and (3) total revenues = $900 million. Delta Investments' CPA firm uses the percentage applicable on total (net) assets for determining overall materiality.

a. Determine overall materiality, and determine tolerable misstatement. Explain your answer.

b. During the course of the audit, Delta’s CPA firm detected two misstatements that aggregated to an overstatement of income of $5.75 million. Evaluate the audit findings. Explain your answer.

Scenario 3:

Swell Computers is a public company that manufactures desktop and laptop computers. The components of the financial statements are: (1) income before taxes = $500,000, (2) total assets = $2.2 billion, and (3) total revenues = $7 billion. Swell Computers' CPA firm might use the lowest percentage for total assets for determining overall materiality, but they also consider qualitative factors.

a. Determine overall materiality and tolerable misstatement. Explain your answer.

b. During the course of the audit, Swell’s CPA firm detected one misstatement that resulted in an overstatement of income by $1.5 million. Evaluate the audit findings. Explain your answer.

Answer 1

Scenario 1

a) It is clear that Murphy & Johnson is private owned company, so it should use 5% of their income before taxes. That is;

The planning materiality
=net income before tax×percentage of income used
=775×5%=38.75million

Here the planning materiality is not an extremely high value so that it should use 50% of net income to help to find out tolerable misstatement. It is because 50% is the safest and lower risker value for calculating tolerable misstatement. That is;

Tolerable misstatement= 38.75million×0.50=19.375million

b) Murphy & Johnson's auditor can advise them to how the relevant adjustments can be made to the financial statement if the detected misstatements are greater than the planned materiality. So the auditor should well aware of the misstatements and its causes because it would be affected the auditor's assessment of risk.

Scenario 2

a) It is clear that Delta investments provides a group of mutual funds for investors, so it should use 5% of their total assets. That is;The planning materiality=total assets×percentage of income used=4.3 billion×5%=21.5 million

Here the planning materiality is not an extremely high value so that it should use 50% of total assets to help to find out tolerable misstatement. It is because 50% is the safest and lower risker value for calculating tolerable misstatement. That is;

Tolerable misstatement
=21.5 million×0.50=10.75 million

b) Delta investments auditor can advise them to how the relevant adjustments can be made to the financial statement if the detected misstatements are greater than the planned materiality. So the auditor should well aware of the misstatements and its causes because it would be affected the auditor's assessment of risk.

Scenario 3

a) It is clear that swell computers is a public company, so it should use 5% of its total revenue. That is;

The planning materiality=total revenue×percentage of income used=
7billion×5%=35 million

Here the planning materiality is not an extremely high value so that it should use 50% of total revenue to help to find out tolerable misstatement. It is because 50% is the safest and lower risker value for calculating tolerable misstatement. That is;

Tolerable misstatement=35million×0.50=17.5million

b) Swell computers auditor can advise them to how the relevant adjustments can be made to the financial statement if the detected misstatements are greater than the planned materiality. So the auditor should well aware of the misstatements and its causes because it would be affected the auditor's assessment of risk.