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this estimate to the segments of the audit, as shown in the first bracket of the figure. These two steps, which are part of planning, are our primary focus for the discussion of materiality in this chapter. Step 3 occurs throughout the engagement, when auditors estimate the amount of misstatements in each segment as they evaluate audit evidence. Near the end of the audit, during the engagement completion phase, auditors proceed through the final two steps. These latter three steps, as shown in the second bracket in Figure 9-1, are part of evaluating the results of audit tests.(Objective 9-2)
SET PRELIMINARY JUDGMENT ABOUT MATERIALITY
Auditing standards require auditors to decide on the combined amount of misstatements in the financial statements that they would consider material early in the audit as they are developing the overall strategy for the audit. We refer to this as the preliminary judgment about materiality. It is called a preliminary judgment about materiality because, although a professional opinion, it may change during the engage ment. This judgment must be documented in the audit files. The preliminary judgment about materiality (step 1 in Figure 9-1) is the maximum amount by which the auditor believes the statements could be misstated and still not affect the decisions of reasonable users. (Conceptually, this is an amount that is $1 less than materiality as defined by the FASB. We define preliminary materiality in this manner for convenience.) This judgment is one of the most important decisions the auditor makes, and it requires considerable professional wisdom. Auditors set a preliminary judgment about materiality to help plan the appropriate evidence to accumulate. The lower the dollar amount of the preliminary judgment, the more evidence required. Examine the financial statements of Hillsburg Hardware Co., in the glossy insert to the textbook. What combined amount of misstatements will affect decisions of reasonable users? Do you believe that a $100 misstatement will affect users’ decisions? If so, the amount of evidence required for the audit is likely to be beyond that for which the management of Hillsburg Hardware is willing to pay. Do you believe that a $10 million misstatement will be material? Most experienced auditors believe that amount is far too large as a combined materiality amount in these circumstances. During the audit, auditors often change the preliminary judgment about materiality. We refer to this as the revised judgment about materiality. Auditors are likely to make the revision because of changes in one of the factors used to determine the preliminary judgment; that is because the auditor decides that the preliminary judgment was too large or too small. For example, a preliminary judgment about materiality is often deter - mined before year-end and is based on prior years’ financial statements or interim finan - cial statement information. The judgment may be reevaluated after current financial statements are available. Or, client circumstances may have changed due to qualitative events, such as the issuance of debt that created a new class of financial statement users. Several factors affect the auditor’s preliminary judgment about materiality for a given set of financial statements. The most important of these are: Materiality Is a Relative Rather Than an Absolute Concept A misstatement of a given magnitude might be material for a small company, whereas the same dollar misstatement could be immaterial for a large one. This makes it impossible to establish dollar-value guidelines for a preliminary judgment about materiality that are appli - cable to all audit clients. For example, a total misstatement of $10 million would be extremely material for Hillsburg Hardware Co. because, as shown in their financial statements, total assets are about $61 million and net income before taxes is less than $6 million. A misstatement of the same amount is almost certainly immaterial for a company such as IBM, which has total assets and net income of several billion dollars. Bases Are Needed for Evaluating Materiality Because materiality is relative, it is necessary to have bases for establishing whether misstatements are material. Net income before taxes is often the primary base for deciding what is material for profit-oriented businesses because it is regarded as a critical item of information for users. Some firms use a different primary base, because net income often fluctuates considerably from year to year and therefore does not provide a stable base, or when the entity is a not-forprofit organization. Other primary bases include net sales, gross profit, and total or net assets. After establishing a primary base, auditors should also decide whether the misstatements could materially affect the reasonableness of other bases such as current assets, total assets, current liabilities, and owners’ equity. Auditing standards require the auditor to document in the audit files the basis used to determine the preliminary judgment about materiality. Assume that for a given company, an auditor decided that a misstatement of income before taxes of $100,000 or more would be material, but a misstatement would need to be $250,000 or more to be material for current assets. It is not appropriate for the auditor to use a preliminary judgment about materiality of $250,000 for both income before taxes and current assets. Instead, the auditor must plan to find all misstatements affecting income before taxes that exceed the preliminary judgment about materiality of $100,000. Because almost all misstatements affect both the income statement and balance sheet, the auditor uses a primary preliminary materiality level of $100,000 for most tests. The only other misstatements that will affect current assets are misclassifications within balance sheet accounts, such as misclassifying a long-term asset as a current one. So, in addition to the primary preliminary judgment of materiality of $100,000, the auditor will also need to plan the audit with the $250,000 preliminary judgment about materiality for misclassifications of current assets. Qualitative Factors Also Affect Materiality Certain types of misstatements are likely to be more important to users than others, even if the dollar amounts are the same. For example:
• Amounts involving fraud are usually considered more important than unin - tentional errors of equal dollar amounts because fraud reflects on the honesty and reliability of the management or other personnel involved. For example, most users consider an intentional misstatement of inventory more important than clerical errors in inventory of the same dollar amount.
• Misstatements that are otherwise minor may be material if there are possible consequences arising from contractual obligations. Say that net working capital included in the financial statements is only a few hundred dollars more than the required minimum in a loan agreement. If the correct net working capital were less than the required minimum, putting the loan in default, the current and non current liability classifications would be materially affected.
• Misstatements that are otherwise immaterial may be material if they affect a trend in earnings. For example, if reported income has increased 3 percent annually for the past 5 years but income for the current year has declined 1 percent, that change may be material. Similarly, a misstatement that would cause a loss to be reported as a profit may be of concern. Accounting and auditing standards do not provide specific materiality guidelines to practitioners. The concern is that such guidelines might be applied without considering all the complexities that should affect the auditor’s final decision. However, in this chapter, we do provide guidelines to illustrate the application of materiality. These are intended only to help you better understand the concept of applying materiality in practice. The guidelines are stated in Figure 9-2 in the form of policy guidelines of a
CPA firm. Notice that the guidelines are formulas using one or more bases and a range of percentages. The application of guidelines, such as the ones we present here, requires considerable professional judgment. Using the illustrative guidelines in Figure 9-2 (p. 253), let’s examine a preliminary judgment about materiality for Hillsburg Hardware Co. The guidelines are as follows:
If the auditor for Hillsburg Hardware decides that the general guidelines are reasonable, the first step is to evaluate whether any qualitative factors significantly affect the materiality judgment. Assuming no qualitative factors exist, if the auditor concludes at the end of the audit that combined misstatements of operating income before taxes are less than $221,000, the statements will be considered fairly stated. If the combined misstatements exceed $442,000, the statements will not be considered fairly stated. If the misstatements are between $221,000 and $442,000, a more careful consideration of all facts will be required. The auditor then applies the same process to the other three bases.
16. 41. Of the approaches to record cash discounts related to accounts receivable, which is more...
41. Of the approaches to record cash discounts related to accounts receivable, which is more theoretically correct?
a. Net approach.
b. Gross approach.
c. Allowance approach.
d. All three approaches are theoretically correct.
42. All of the following are problems associated with the valuation of accounts receivable except for
a. uncollectible accounts.
b. returns.
c. cash discounts under the net method.
d. allowances granted.
43. Why is the allowance method preferred over the direct write-off method of accounting for bad debts?
a. Allowance method is used for tax purposes.
b. Estimates are used.
c. Determining worthless accounts under direct write-off method is difficult to do.
d. Improved matching of bad debt expense with revenue.
44. Which of the following concepts relates to using the allowance method in accounting for accounts receivable?
a. Bad debt expense is an estimate that is based on historical and prospective information.
b. Bad debt expense is based on the actual amounts determined to be uncollectible.
c. Bad debt expense is an estimate that is based only on an analysis of the receivables aging.
d. Bad debt expense is management's determination of which accounts will be sent to the attorney for collection.
45. How can accounting for bad debts be used for earnings management?
a. Determining which accounts to write-off.
b. Changing the percentage of sales recorded as bad debt expense.
c. Using an aging of the accounts receivable balance to determine bad debt expense.
d. Reversing previous write-offs.
46. What is the normal journal entry for recording bad debt expense under the allowance method?
a. Debit Allowance for Doubtful Accounts, credit Accounts Receivable.
b. Debit Allowance for Doubtful Accounts, credit Bad Debt Expense.
c. Debit Bad Debt Expense, credit Allowance for Doubtful Accounts.
d. Debit Accounts Receivable, credit Allowance for Doubtful Accounts.
47. What is the normal journal entry when writing-off an account as uncollectible under the allowance method?
a. Debit Allowance for Doubtful Accounts, credit Accounts Receivable.
b. Debit Allowance for Doubtful Accounts, credit Bad Debt Expense.
c. Debit Bad Debt Expense, credit Allowance for Doubtful Accounts.
d. Debit Accounts Receivable, credit Allowance for Doubtful Accounts.
48. Which of the following is included in the normal journal entry to record the collection of accounts receivable previously written off when using the allowance method?
a. Debit Allowance for Doubtful Accounts, credit Accounts Receivable.
b. Debit Allowance for Doubtful Accounts, credit Bad Debt Expense.
c. Debit Bad Debt Expense, credit Allowance for Doubtful Accounts.
d. Debit Accounts Receivable, credit Allowance for Doubtful Accounts.
49. Assuming that the ideal measure of short-term receivables in the balance sheet is the discounted value of the cash to be received in the future, failure to follow this practice usually does not make the balance sheet misleading because
a.most short-term receivables are not interest-bearing.
b.the allowance for uncollectible accounts includes a discount element.
c.the amount of the discount is not material.
d.most receivables can be sold to a bank or factor.
50. Which of the following methods of determining bad debt expense does not properly match expense and revenue?
a.Charging bad debts with a percentage of sales under the allowance method.
b.Charging bad debts with an amount derived from a percentage of accounts receivable under the allowance method.
c.Charging bad debts with an amount derived from aging accounts receivable under the allowance method.
d.Charging bad debts as accounts are written off as uncollectible.
17. Objective 2.6 1) Which of the following formulas determine cost of goods sold in a merchandising ent
Objective 2.6
1) Which of the following formulas
determine cost of goods sold in a merchandising entity?
A) Beginning inventory + Purchases +
Ending inventory = Cost of goods sold
B) Beginning inventory + Purchases –
Ending inventory = Costs of goods sold
C) Beginning inventory – Purchases +
Ending inventory = Cost of goods sold
D) Beginning inventory – Ending inventory
– Purchases = Cost of goods sold
2) Which of the following formulas
determine cost of goods sold in a manufacturing entity?
A) Beginning work-in-process inventory +
Cost of goods manufactured – Ending work-in-process inventory = Cost of goods
sold
B) Beginning work-in-process inventory +
Cost of goods manufactured + Ending work-in-process inventory = Cost of goods
sold
C) Cost of goods manufactured – Beginning
finished goods inventory – Ending finished goods inventory = Cost of goods sold
D) Cost of goods manufactured + Beginning
finished goods inventory – Ending finished goods inventory = Cost of goods sold
3) A company reported revenues of
$375,000, cost of goods sold of $118,000, selling expenses of $11,000, and
total operating costs of $70,000. Gross margin for the year is ________.
A) $257,000
B) $246,000
C) $176,000
D) $252,000
Answer
the following questions using the information below:
Leslie
Manufacturing reported the following:
Revenue
$450,000
Beginning inventory of direct materials,
January 1, 2015
20,000
Purchases of direct materials
156,000
Ending inventory of direct materials,
December 31, 2015
18,000
Direct manufacturing labor
21,000
Indirect manufacturing costs
42,000
Beginning inventory of finished goods,
January 1, 2015
40,000
Cost of goods manufactured
114,000
Ending inventory of finished goods,
December 31, 2015
45,000
Operating costs
150,000
4) What is Leslie’s cost of goods sold?
A)
$103,000
B)
$109,000
C)
$112,000
D)
$118,000
5) What is Leslie’s gross margin (or gross
profit)?
A)
$103,000
B)
$152,000
C)
$341,000
D)
$317,000
6) Inventoriable costs and period costs
flow through the income statement at a merchandising company similar to the way
costs flow at a manufacturing company.
7)
Cost of goods sold refers to the products brought to completion, whether they
were started before or during the current accounting period.
18. ACC-201-Q5560 Financial Accounting 18EW5 5-1 Final Project Milestone Two: Accounting Workbook (St...
ACC-201-Q5560 Financial Accounting 18EW5
5-1 Final Project Milestone Two: Accounting Workbook (Steps 1–7)
Assignment
In this second milestone of your final project, you will move through the next phase of the accounting cycle by creating the trial balance, adjusted entries, and adjusted trial balance.
To complete this assignment, review the Milestone Two Guidelines and Rubric document Peyton Approved 2018 Trial Balance
19. Exercise 5-15 Franchises; residual method [LO5-6, 5-7] Monitor Muffler sells franchise arrangements.
Exercise 5-15 Franchises; residual method [LO5-6, 5-7] Monitor Muffler sells franchise arrangements throughout the United States and Canada. Under a franchise agreement, Monitor receives $600,000 in exchange for satisfying the following separate performance obligations: (1) franchisees have a five-year right to operate as a Monitor Muffler retail establishment in an exclusive sales territory, (2) franchisees receive initial training and certification as a Monitor Mechanic, and (3) franchisees receive a Monitor Muffler building and necessary equipment. The stand-alone selling price of the initial training and certification is $15,000, and $450,000 for the building and equipment. Monitor estimates the stand-alone selling price of the five-year right to operate as a Monitor Muffler establishment using the residual approach. Monitor received $75,000 on July 1, 2016, from Perkins and accepted a note receivable for the rest of the franchise price. Monitor will construct and equip Perkins’ building and train and certify Perkins by September 1, and Perkins’ five-year right to operate as a Monitor Muffler establishment will commence on September 1 as well. 1. What amount would Monitor calculate as the stand-alone selling price of the five-year right to operate as a Monitor Muffler retail establishment? $135.000 2. What journal entry would Monitor record on July 1, 2016, to reflect the sale of a franchise to Dan Perkins? (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.) 7/1/16 Cash 75,000 (debit) 525,000 (debit) 600000 (credit) 3. How much revenue would Monitor recognize in the year ended December 31, 2016, with respect to its franchise arrangement with Perkins? (Ignore any interest on the note receivable.) Total Revenue ????
20. Process Reengineering includes all of the following steps except
Process Reengineering includes all of the following steps except:
A) constructing a diagram flowcharting the current process.
B) redesigning the process.
C) elimination of non-value-added activities.
D) elimination of all constraints.
21. (FIFO and LIFO—Periodic) Johnny Football Shop began operations on January 2, 2014. The follow-
(FIFO and LIFO—Periodic) Johnny Football Shop began operations on January 2, 2014. The follow- ing stock record card for footballs was taken from the records at the end of the year.
Date Voucher Terms Units
Received Unit Invoice
Cost Gross Invoice
Amount
1/15 10624 Net 30 50 $20 $1,000
3/15 11437 1/5, net 30 65 16 1,040
6/20 21332 1/10, net 30 90 15 1,350
9/12 27644 1/10, net 30 84 12 1,008
11/24 31269 1/10, net 30 76 11 836
Totals 365 $5,234
A physical inventory on December 31, 2014, reveals that 100 footballs were in stock. The bookkeeper informs you that all the discounts were taken. Assume that Johnny Football Shop uses the invoice price less discount for recording purchases.
(a) Compute the December 31, 2014, inventory using the FIFO method.
(b) Compute the 2014 cost of goods sold using the LIFO method.
(c) What method would you r ecommend to the owner to minimize income taxes in 2014, using the
inventory information for footballs as a guide?
