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Possible audit adjustments: materiality levels

In your audit for calendar 2009, you found a number of matters that you believe represent possible adjustments to the company's books. These matters are described below. Management's attitude is that "once the books are closed, they're closed," and management does not want to make any adjustments. Planning materiality for the audit was $100,000, determined by computing 5% of expected income before taxes. Actual income before taxes on the financial statements is $1,652,867.

Possible adjustments:

1. Several credit memos that were processed and recorded after year-end relate to sales and accounts receivable for 2009. These total $26, 451

2. Inventory cutoff tests indicate that $25,673 of inventory received on December 30, 2009, was recorded s purchases and accounts payable in 2010. These items were included in the inventory count at year-end and therefore were included in ending inventory.

3. Inventory cutoff tests also indicate several sales invoices recorded in 2009 for goods that were shipped in early 2010. The goods were included in inventory even though they were set aside in separate shipping area. The total amount of these shipments was $41,814.

4. The company wrote several checks at the end of 2009 for accounts payable that were held and not mailed until January 15, 2010. These totaled $43,671. Recorded cash and accounts payable at December 31, 2009 are $2,356,553 and $2,666,290, respectively.

5. The company has not established a reserve for obsolescence of inventories. Your tests indicate that such a reserve is appropriate in an amount somewhere between $15,000 and $30,000.

6. Your review of the allowance for uncollectible accounts indicate that it may be understated by between $35,000 and $55,000.
a. Determine the adjustments that you believe must be made for the company's financial statements to be fairly presented. Include the amounts and accounts affected by each adjustment
b. Why may the company's management resists making these adjustments?
c. Explain what you consider the most positive way of approaching management personnel to convince them to make your proposed changes.
d. Describe your responsibilities related to unadjusted misstatements that management has determined are immaterial individually and in the aggregate
e. Assuming this company is a public company, describe how the noted adjustments might impact your audit report on internal control over financial reporting.

Solution Preview

Requirement A

Situation 1
DR: Sales discounts and allowances 26,453
CR: Accounts receivable 26,453

Situation 2
DR: Purchases 25,673
CR: Accounts payable 25,673

Situation 3
DR: Sales revenue 41,814
CR: Accounts receivable 41,814

Situation 4
DR: Cash 43,671
CR: Accounts payable 43,671

Situation 5
DR: Obsolescence expense 20,000
CR: Allowance for inventory obsolescence 20,000
*Used the average

Situation 6
DR: Doubtful accounts expense 45,000
CR: Allowance for doubtful accounts 45,000

All of ...

Solution Summary

The expert examines possible audit adjustments for materiality levels.