Chapter 3, Problem 3.32P

a

To determine

Introduction:

Materiality: The theory of materiality is important to audit practice. It is planning and executing the audit process using the concept of materiality and its application to audit risk. Materiality is used to check if misstatements in the financial statements and disclosures are significant. Once misstatements are identified, the auditor requires reliable evidence in support of findings.

The overall materiality and tolerable misstatement using income before taxes for the year 2018.

Answer to Problem 3.32P

• Determination of Materiality.

Income before taxes, $25,950,000 or 25.95 million

• Determination of tolerable misstatement.

Income before taxes = $12,975,000 or 12.98 million

Explanation of Solution

Determination of Materiality and tolerable misstatement.

If the current year income before tax is not stable “normalized earnings” − last three years average income before tax can be usedto assess overall Materiality.

Average of Last three years = $\frac{\$584+\$520+\$453}{3}=\$519$

• Determination of Materiality.

When 5 percent of the benchmark is applied for overall materiality, the materiality of M&J will be:

Income before taxes, $25,950,000 = $\$519,000,000\times 0.05$

Or 25.95 million

• Determination of tolerable misstatement.

The tolerable misstatement is usually kept in between 50 to 75 percent for each of the accounts of overall materiality. Thus, 50 percent of tolerable misstatement is assumed.

Income before taxes = $12,975,000 = $\$25,950,000\times 0.5$

Or 12.97 million.

b

To determine

Introduction:

Materiality: The theory of materiality is important to audit practice. It is planning and executing the audit process using the concept of materiality and its application to audit risk. Materiality is used to check if misstatements in the financial statements and disclosures are significant. Once misstatements are identified, the auditor requires reliable evidence in support of findings.

The overall materiality, tolerable misstatement using either total assets or total revenues as the benchmark anduse .25% and 2% for calculation.

Answer to Problem 3.32P

	2018	2017	2016	2015
Overall Materiality at .25%
Total Assets (million)	$58.55	$40.34	$33.1	$29.9
Total Revenue (million)	$50.7	$33.22	$23	$22.46
Tolerable misstatement:
Total Assets (million)	29.3	20.17	16.55	14.95
Total Revenue (million)	25.35	16.61	11.5	11.23
Overall Materiality at 2%
Total Assets (million)	$468.44	$322.7	$264.8	$239.32
Total Revenue (million)	$405.44	$265.8	$183.8	$179.7
Tolerable misstatement:
Total Assets (million)	$234.22	$161.35	$132.4	$119.66
Total Revenue (million)	$202.72	$132.89	$92	$89.85

Explanation of Solution

a. Determination of Materiality and tolerable misstatement.

• Determination of Materiality.

When.25 percent of the benchmark is taken for overall materiality.

2018:

Total revenue, $50.7 million = $\$20,272\times 0.0025$

Total Assets, $58.55 million = $\$23,422\times 0.0025$

2017:

Total revenue, $33.22 million = $\$13,289\times 0.0025$

Total Assets, $40.34 million = $\$16,137\times 0.0025$

2016:

Total revenue, $23 million = $\$9,189\times 0.0025$

Total Assets, $33.1 million = $\$13,239\times 0.0025$

2015:

Total revenue, $22.46 million = $\$8,984\times 0.0025$

Total Assets, $29.9 million = $\$11,966\times 0.0025$

Assuming 2 percent of the benchmark is appropriate for overall materiality.

2018:

Total revenue, $405.44 million = $\$20,272\times 0.02$

Total Assets, $468.44 million = $\$23,422\times 0.02$

2017:

Total revenue, $265.8 million = $\$13,289\times 0.02$

Total Assets, $322.7 million = $\$16,137\times 0.02$

2016:

Total revenue, $183.8 million = $\$9,189\times 0.02$

Total Assets, $264.8 million = $\$13,239\times 0.02$

2015:

Total revenue, $179.7 million = $\$8,984\times 0.02$

Total Assets, $239.32 million = $\$11,966\times 0.02$

• Determination of tolerable misstatement.

The tolerable misstatement is usually kept in between 50 to 75 percent for each of the accounts of overall materiality. Thus, we assume 50 percent of tolerable misstatement.

Tolerable misstatement for .25 percent overall materiality

2018:

Total revenue, $25.35 million = $\$50.7\times 0.5$

Total Assets, $29.3 million = $\$58.55\times 0.5$

2017:

Total revenue, $16.61million = $\$33.22\times 0.5$

Total Assets, $20.17 million = $\$40.34\times 0.5$

2016:

Total revenue, $11.5 million = $\$23\times 0.5$

Total Assets, $16.55 million = $\$33.1\times 0.5$

2015:

Total revenue, $11.23 million = $\$22.46\times 0.5$

Total Assets, $14.95 million = $\$29.9\times 0.5$

Tolerable misstatement for 2 percent overall materiality

2018:

Total revenue, $207.25 million = $\$414.5\times 0.5$

Total Assets, $234.22 million = $\$468.44\times 0.5$

2017:

Total revenue, $132.89 million = $\$265.8\times 0.5$

Total Assets, $161.35 million = $\$322.7\times 0.5$

2016:

Total revenue, $92 million = $\$183.8\times 0.5$

Total Assets, $132.4 million = $\$264.8\times 0.5$

2015:

Total revenue, $89.85 million = $\$179.7\times 0.5$

Total Assets, $119.66 million = $\$239.32\times 0.5$

c

To determine

Introduction:

Materiality: The theory of materiality is important to audit practice. It is planning and executing the audit process using the concept of materiality and its application to audit risk. Materiality is used to check if misstatements in the financial statements and disclosures are significant. Once misstatements are identified, the auditor requires reliable evidence in support of findings.

The overall materiality of misstatement of $50 million based on calculations in part a, and b.

Answer to Problem 3.32P

A misstatement is material in case of income before tax and immaterial when done using total assets and total revenue.

Explanation of Solution

a. Evaluation of misstatements of an overstatement of income of $50 million.

The misstatements and tolerable misstatement are compared with each other. If misstatement is greater than tolerable misstatement or if aggregate misstatements were greater than overall materiality, the business has to correct the financial statements or else auditor will issue qualified or adverse opinion.

When theincome before taxes is evaluated for overall materiality in case of KR,there is a misstatement of $50 million in 2018 which is both greater than tolerable misstatement and overall materiality.

Income before taxes:

KR’s overall materiality is $25.95 million and tolerable misstatement is $12.98 million, even if the average of last three year is taken to determine materiality.

Thus, it can be concluded that they have to adjust misstatement in the financial statements or auditor will issue qualified or adverse opinion.

Total Assets

KR overall materiality and tolerable misstatement are above misstatement of $50 million.

As misstatement is below than the overall materiality and tolerable misstatement, it can be assumed that asset balances are fairly stated in accordance with GAAP.

Total revenue

KR overall materiality and tolerable misstatement are above misstatement of $50 million.

As misstatement is below the overall materiality and tolerable misstatement, it can be assumed that asset balances are fairly stated in accordance with GAAP.