Question

The following financial information was extracted from MCL’s current draft financial statements and those of the previous year:​

2017 ($M) 2016 ($M) 2015 ($M) Revenue 220 260 240 Total assets 260 280 250 Net Profit before tax 19 (3) 17

The car parts and accessories industry has been very competitive and consumer demand appears to be slowing in anticipation of change with electric and driverless cars coming into the market. The company has recently restructured its operations to outsource its New Zealand manufacturing to a new factory in China from May 2017.

Required:

a) Select an appropriate benchmark for determining the preliminary figure for materiality for MCL and briefly explain your selection.

b) Identify three risk factors and briefly explain why they will affect audit planning. Include in your explanation how such risks affect preliminary overall materiality. (7 marks

Answer 1

(a) Materiality is the amount that makes difference to the users. An audit never provides 100% assurance, it only provides reasonable assurance.

Also Materiality is a matter of proffessional judgement. So, no single method or assumption is correct.

Materiality is decided initially in the planning stage but, it is extended to further procedures also, it is a continual procedure.

So, Materiality is an importantt tool in auditing and also preparation of financial statements. It is professional judgement which one needs to use his owm knowlwdge and assumption.

There are many common bases or benchmarks for determining the preliminary figure for materiality whcich are:

• Profit Before Tax
• Turnover(excluding extraordinary Income)
• Gross Profit
• Total Assets
• Total Equity

there are certain factors which are needed to be considered , those are:

Relevance

Stability

Prediction

We need to take care of all these factors when determining the appropriate benchmark for the company.

Say for E.g 1 . Generally Profit is considered to be the most appropriate benchmark but, for a non-profit organisation or charity companies,this driver is not at all appropriate.

E.g 2 . Revenue can also be a key benchmark but for a comapny which is has a fluctuating revenue, this driver does not work.

Gross Profit is Total Revenue minus Cost of Goods Sold , so, for a company which has a fluctuating revenue this driver is not appropriate.

Thus a person needs to make appropriate judgement regarding the selection of benchmark for determining the preliminary figure for materialiy.

In the given case, Appropriate benchmark for determining the preliminary figure for materiality for MCL is,

Total Assets: Reason for chosing Total Assets as a benchmark is:

As specified in the question the car parts and accessories industry has been very competitive and consumer demands appears to be slowing in anticipation of change with electric and driveless cars coming in the market. And also the company has recently restructured its operations to outsource what it has been manufacturing till now.

Hence it isvery clear that the company does not have a stable revenue and profit thus,

for the given case Total Assets is the best benchmark for the materiality.

(b) Risk factors that will affect audit planing are:

• Accepatble audit Risk- This occurs due to judgemets and also we do not test on 100% population, thus an audit always provides Reasonable assurance.
• Risk of material mistatements- This occurs if the management has prepared the financial statements and has left it materially mistated. It means that the financial statements contain a material mistatements due to fraud or error.( IR*CR)

- Inherent Risk

- Control Risk.

These risk factors shal affect audit planing as a financial statement with higher risk needs detailed audit procedures to be applied to it . it is directly proportional higher the risk , higher the planing and higher the procedures.

the elements of financial statements which has high risk ,tends to be less reliable, but if it is relevant then it shall be taken to be benchmark for materiality.