Question

You are an auditor assigned to XYZ’s Company’s annual audit. The company has not reported an item because management’s assertion is that the item is immaterial. You may agree or disagree. Construct an argument that supports whether you agree or disagree with management’s assertion. Support your answer with examples.

The Securities and Exchange Commission (SEC) is a key governing body when it comes to financial statements. Evaluate the effectiveness of the SEC over financial statement reporting and take a position as to its effectiveness. Construct an argument that supports your position that the SEC is not effective or is effective in regulating financial reporting. Support your answer with example

Answer 1

(a) The auditor agrees with management's assertion.

During the course of auditing year-financial statements, it was found that an item was not reported and its effect on total revenue was 2% and on net income was 2% $.01 overstatement of earning per share. Because no item in the financial statements is misstated by more than 5% the independent auditor and management conclude that the deviation from GAAP is immaterial and the accounting is permissible. For example, In Parnes v. Gateway 2000, the U.S. Court of Appeals for the Eight Circuit concluded that the defendant's alleged overstatement of assets by $6.8 million, amounting to only 2 per cent of the Company's total assets, was not material because, "reasonable investor, faced with high risk/high-yield investment opportunity in a company with a history of rapid growth, would not have been put off by an asset column that was 2 per cent smaller."

(b) SEC is an effective governing body.

All the stakeholders make materiality decisions, so it is crucial to check material assertions by auditor. Despite rejection of universal quantitative standard for materiality, SEC and other authoritative bodies had on certain occassions issued quantitative materiality guidance for certain specified situations.

One example of quantitative materiality guidance is SEC Regulation SX, Rule 504, which notes that with respect to receivables from officers and stockholders, registrants must disclose details of receivables from any officer or principal stockholder it if equals or exceeds $20,000 or 1 per cent of total assets. Thus when a receivable exeeds 1 per cent of total assets it has to be disclosed.

The SEC has also issued other effective quantitative materiality guidance notes for various specified situations to give true and fair view of the financial statements and help investors in decision making .