Auditing Cases: an Interactive Learning Approach Case 7.1

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Planning Materiality and Tolerable Misstatement

Planning Materiality and Tolerable Misstatement

Information from Ann Aylor Stores Corporation’s 3/20/2008 form 10-K report was used in developing this case (Beasley, Buckless, Glover, & Prawitt, 2012).

1. Why are different materiality bases considered when determining planning materiality?

a. The financial information is prepared for multiple users for different purposes. Not all elements of the financial statements are equally relevant to all users.

2. Why are different materiality thresholds relevant for different audit engagements?

b. Materiality is not an absolute concept but rather a relative one. Materiality thresholds that influence users of the financial statements vary depending on the context in which the company operates. The magnitude of a misstatement that can influence financial statement users varies depending on how the entity is performing relative to its industry. Small misstatements have more influence for a company just barely achieving the industry average compared to a company significantly over- or under-achieving relative to their industry averages.

3. Why is the materiality base that results in the smallest threshold generally used for planning purposes?

c. Because of the dual entry nature of accounting, misstatements will result in at least two accounts being affected. Since most misstatements affect both a balance sheet and income statement account, auditors must design and plan the audit to find the smallest misstatement that would influence the financial statement users. In order to provide reasonable assurance that the financial statements are free of material misstatements, the audit must be designed to detect the smallest misstatement that would influence its users.

4. Why is the risk of management fraud considered when determining tolerable misstatement?

d. The likelihood of management fraud makes it highly more...