Question

For each of the following scenarios, perform the three steps in the materiality process: (1) determine overall materiality, (2) determine tolerable misstatement, and (3) evaluate the audit findings.

Assume further that the auditor’s firm provides guidance that tolerable misstatement will be set 50% of overall materiality.

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. Justify your decisions.

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. Justify your decisions.

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. Justify your decisions.

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. Justify your decisions.

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. Justify your decisions.

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. Justify your decisions.

Answer 1

SCENARIO 1

a)As Murphy & Johnson is a privately owned company, we will use 5% of net income before taxes

the net income before taxes = $21 million

planning materiality =$1,050,000.( $21 million *5%)

Now we will use 50% to help determine tolerable misstatement, as it is a safer value to use whencalculating tolerable misstatements because it has a lower risk. By taking the overall materialityof $1,050,000 and multiplying it by 50%, the tolerable misstatement comes out to be $609,000

b)the total of two misstatement is greater than the overall materiality error in financial statement.

SCENARIO 2

a) Delta is a mutual fund entity.hence we should use 5% of net asset value.

planning materiality = $4.3 billion *5%= $215000000

tolerable misstatement = $609000

SCENARIO 3

a)Swell computer is a public owned company, we will use 5% of total sset

total asset = $2,2 billion

planning materiality = $11,000,000

tolerable misstatement = $5050000

b))the total of two misstatement is greater than the overall materiality error in financial statement.