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EarthWear Materiality Mini-Case
EarthWear Materiality Mini-Case
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Wo rd Do c u m e n t
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EarthWear Hands-on Mini-case
Chapter 3 - Overall Materiality and Tolerable Misstatement
AUDITING & ASSURANCE SERVICES 11e © The McGraw-Hill Companies, Inc., 2019
In this mini-case you will determine overall materiality as well as tolerable misstatement amounts for
balance sheet accounts of EarthWear Clothiers, Inc. Most auditing firms use a simple approach for
establishing planning materiality and tolerable misstatement similar to the one illustrated in your
textbook. This case illustrates such an approach, with some additional guidance from Willis & Adams
relating to the amount of tolerable misstatement to allocate to various balance sheet accounts based
on difficulty to audit and expected misstatement, and limiting the total amount of tolerable
misstatement to about ten times materiality.
INSTRUCTIONS
Read the Materiality Guidelines for Willis & Adams CPAs. To open the guidelines document please
double-click on the following icon. A document will open in Microsoft Word.
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Wo rd Do c u m e n t
Following the Materiality Guidelines for Willis & Adams CPAs, complete all the fields on Work Paper 3-
7 indicated in yellow (Work Paper 3-7 is found on the next tab of this worksheet). For your
convenience, EarthWear Financial Statements have been included in worksheet tabs after the working
papers.
Fields you are to complete on work papers are colored yellow. The color will disappear when the field is completed.
Following the Materiality Guidelines for Willis & Adams CPAs, complete all the fields on Work Paper 3-
8 indicated in yellow.
Fields you are to complete on work papers are colored yellow. The color will disappear when the field is completed.
When completed with the work papers, enter your initials in the yellow box with title
"Initial Here".
Please input your answers into Connect or print hard copies of work papers 3-7 and 3-8 to submit
unless your instructor requests an electronic submission. The work papers are each formatted to fit on
one page.
Name:
Class:
EARTHWEAR CLOTHIERS 3-7
Planning Materiality ZM
December 31, 2019 9/30/2020
(In thousands)
Unaudited
1. Benchmark Data 2019 2018
Sales / Revenue $1,019,890 $950,484
Pre-tax income $70,154 $35,757
Total assets $389,428 $329,959
Materiality $1,800
Measurement Base:
We choose pre tax income as the measurement base because it looks like the auditor in 2018 used pretax income as
the materiallity basis, so we wanted to be consistent with that. Since Earthwear is a profit based company, pretax
income is the best materiality basis, and it is not super volatile, and rather is growing.
Percentage:
Since 3-7% is the relative materiality range, where below 3 is immaterial and above 7 is material, we decided to go right
in the middle of this range and choose 5%. Futhermore, for publicially traded companies, materiality is set at 5% or
less, so we decided 5% would be an appropriate amount.
Name:
Class:
Tolerable Misstatement as % of
2019 Unaudited Tolerable Planning Account
Account Name 2018 Trial Balance Misstatement Materiality * Balance ** Explanation
Cash and cash equivalents $48,978 $79,359 $2,105 60% 3% Large account, but can be easily verifiable, little risk of misstatement
Receivables, net $12,875 $8,643 $2,161 62% 25% Smaller account,but costly to audit, misstatements likely
Inventory $122,337 $147,693 $2,631 75% 2% Large and complex account with misstatements expected, costly to audit
Prepaid expenses $17,772 $15,647 $1,754 50% 11% Smaller account, could have misstatements
Deferred income tax benefits $7,132 $10,338 $2,631 75% 25% Relatively complex, estimation involved, related to Deferred Income Taxes
Property, Plant, & Equipment $206,426 $223,736 $1,754 50% 1% Relatively little change from prior year, not difficult to audit
Accumulated depreciation and amortization $85,986 $97,722 $2,631 75% 3% Large and complex account , costly to audit
Intangibles, net $423 $1,734 $434 12% 25% Relatively little volume, can't be more than 25% of the intangibles account value
Lines of credit $11,011 $10,510 $1,754 50% 17% Relatively little volume, not difficult to audit via 3rd party info
Accounts payable & Reserve for returns $68,399 $60,286 $2,631 75% 4% Large account, could have misstatements with estimation of returns
Accrued liabilities & Accrued profit sharing $28,270 $33,600 $2,105 60% 6% Moderate sized account, not that difficult to verify owed liabilities
Income taxes payable & Deferred income taxes $18,057 $24,567 $1,754 50% 7% Smaller account, income taxes can be verified
Common stock, 26,121 shares issued $261 $261 $65 2% 25% No change from prior year, easily verified
Donated capital $5,460 $5,460 $1,365 39% 25% No change from prior year, easily verified
Additional paid-in capital $20,740 $25,719 $1,754 50% 7% Little change from prior year, not difficult to audit
Deferred compensation ($79) ($36) $0 0% 0% Not difficult to audit, examine current year vesting activity
Accumulated other comprehensive income $3,883 $2,173 $543 15% 25% Involves some complex applications of GAAP
Retained earnings $317,907 $361,402 Not Applicable Not Applicable Not Applicable Not Applicable
Treasury stock, 6,546 and 6,706 shares at cost, respectively ($143,950) ($134,512) $1,754 50% 1% Little change from prior year, not difficult to audit
Total Amount of Tolerable Misstatement Allocated To Balance Sheet Accounts $29,823
Planning Materiality (from work paper 3-7) $3,508
Ratio of Total Tolerable Misstatement to Planning Materiality *** 8.5
December 31
### ###
Assets 2019 (unaudited)
Current Assets:
Cash and cash equivalents $79,359 $48,978 $49,668
Receivables, net $8,643 $12,875 $11,539
Inventory $147,693 $122,337 $105,425
Prepaid advertising $10,212 $11,458 $10,772
Other prepaid expenses $5,435 $6,315 $3,780
Deferred income tax benefits $10,338 $7,132 $6,930
Total current assets $261,680 $209,095 $188,115
Property, plant and equipment, at cost
Land and buildings $76,560 $70,918 $66,804
Fixtures and equipment $68,632 $67,513 $66,876
Computer hardware and software $75,400 $64,986 $47,466
Leasehold improvements $3,144 $3,010 $2,894
Total property, plant and equipment $223,737 $206,426 $184,040
Less - accumulated depreciation and amortization $97,722 $85,986 $76,256
Property, plant and equipment, net $126,014 $120,440 $107,784
Intangibles, net $1,734 $423 $628
Total assets $389,428 $329,959 $296,527
Accumulated
Additional Other
Comprehensive Common Donated Paid-in Deferred Comprehensive Retained Treasury
Income Stock Capital Capital Compensation Income Earnings Stock Total
Balance, December 31, 2016 $261 $5,460 $17,546 ($257) $1,302 $264,158 ($130,844) $157,626
Purchase of treasury stock ($2,935) ($2,935)
Issuance of treasury stock $4,317 $4,317
Tax benefit of stock options exercised $1,765 $1,765
Deferred compensation expense $103 $103
Comprehensive income:
Net income $31,222 $31,222 $31,222
Foreign currency translation adjustments $60 $60 $60
Unrealized gain on forward contracts $377 $377 $377
Comprehensive income $31,659
Balance, December 31, 2017 $261 $5,460 $19,311 ($154) $1,739 $295,380 ($129,462) $192,534
Purchase of treasury stock ($18,192) ($18,192)
Issuance of treasury stock $3,704 $3,704
Tax benefit of stock options exercised $1,429 $1,429
Deferred compensation expense $75 $75
Comprehensive income:
Net income $22,527 $22,527 $22,527
Other comprehensive income:
Foreign currency translation adjustments ($1,151) ($1,151) ($1,151)
Unrealized gain on forward contracts $3,295 $3,295 $3,295
Comprehensive income $24,671
Balance, December 31, 2018 $261 $5,460 $20,740 ($79) $3,883 $317,907 ($143,950) $204,222
Purchase of treasury stock ($8,052) ($8,052)
Issuance of treasury stock $17,490 $17,490
Tax benefit of stock options exercised $4,979 $4,979
Deferred compensation expense $42 $42
Comprehensive income: $43,495
Net income $43,495 $43,495
Other comprehensive income:
Foreign currency translation adjustments ($221) ($221) ($221)
Unrealized gain on forward contracts ($1,489) ($1,489) ($1,489)
Comprehensive income $41,785
Balance, December 31, 2019 $261 $5,460 $25,719 ($36) $2,173 $361,402 ($134,512) $260,467
Other data:
Net working capital 141,063 92,827 90,048 57,863 76,136
Capital expenditures 26,334 28,959 18,208 30,388 31,348
Depreciation and amortization expense 17,515 15,231 13,465 12,175 9,833
Return on average shareholders' investment 19% 11% 18% 13% 28%
Return on average assets 12% 7% 11% 7% 16%