Uncorrected Misstatement and Performance Materiality. Rivers, CPA is auditing the financial statements of Charger Company, a client for the past five years. During past audits of charger, River has only identified some immaterial misstatements (most of which relate to isolated matters and do not have common characteristics). A summary of these misstatements is shown below (to illustrate, in 2005, the misstatements would have reduced net income by $13,200 if corrected).
Year effect on net income effect on Asset effect on liability effect on Equity
2005 ($13,200) ($20,000) ($6,800) ($13,200)
2006 $5,000 $12,000 $7,000 $5,000
2007 ($9,250) ($11,000) ($1,750) ($9,250)
2008 ($2,000) ($5,500) ($3,500) ($2,000)
2009 $1,000 $1,000 $0 $1,000
During the most recent audit, Rivers concluded that sales totaling $11,000 were recognized as of December 31,2010, that did not meet the criteria for recognition until 20011. When Rivers discussed these sales with turner, the chief financial officer of charger company, Turner asked Rivers about the performance materiality level used in the audit, which was $25,000. Upon learning of this,Turner remarked, Then there's no need to worry, it's not a material amount. Why should we bother with this item?
There are a few different problems with this scenario that need to be taken into consideration. Based on the chart given, there are certain trends that have occurred repeatedly. Net income has been overstated every single year for the past five years straight. This in itself is a major factor for a high risk audit. Looking at the assets column, it is also significant to note that assets have also been overstated, and if they were correctly stated, they would have been reduced by the appropriate amounts each year, and the fact that owner's equity is overstated is also a problem. We have three significant areas that are consistently overstated, which drastically affect the financial statements, net income, assets, and equity. Although liabilities are a concern, ...
The solution provides a detailed discussion and analysis determining if the uncorrected misstatement are significant, and if the company should bother with the item or not, as suggested by the Chief Financial Officer.