SARBOX SCOOTER, INC. 8
SarboxScooter, Inc. Case 5.6
Materiality concept of audit
Beforeconducting an audit, the auditor needs to conduct come priorpreparation so as to make the whole process effectively. They need toprepare an audit planning memo that provides a summary of what isexpected to be done so as to meet the need of the client. The auditprocess is always conducted under the international accountingstandards and the generally accepted accounting principle (Alvin,Elder & Beasley, 2010).The Materiality principle of accounting ismost observed and applied in identifying what to test in the auditprocess. Before the auditor prepared an audit plan, he has todetermine what to test basing this on the materiality of the wholeprocess. About the Materiality principle, the auditor needs toidentify the significant accounts to be based on. That is, it is notpossible to conduct audit test to all accounts of an entity, butrather an auditor using his or her experience may select a fewaccounts that are significant to provide a general view of theorganization`s performance. Most of the accounts or financialstatements prepared by entities include the: trial balance, cash flowstatement, cash and cash equivalent, income statement, the balancesheet (statement of financial position), among other. In case theentity has some branches on the various part the ‘mother’ branchis required to prepare consolidated accounts.
Itis out of the above-listed accounts the auditor will identify thesignificant accounts to conduct the audit test. For instance in ourcase study Sarbox Scooter we can identify the significant accounts onthe consolidated balance sheet provided. In this context, we mayrefer to the materiality of the accounts taking into account thetotal earnings of the entity and financial changes in the differentannual accounts of the entity in a single accounting period. Forinstance, review the quarterly and semi-annual accounts of theentity. The Sarbox value of 23.5 million, in this case, may beconsidered insignificance because it is less that 10%. For amisstatement to be considered significant, it should be more than 10%
Thesecond criteria that are applied by the auditor under the auditplanning are to determine whether to select the significant accountsby qualitative or quantitative characteristics.
Qualitativefactors in materiality
Afteridentifying the materiality of the accounts to be audited, an accountmay be selected depending on whether the auditor is basing his or heraudit on quality or quantity of information required by the client.
Thequalitative significance of the accounts is mostly appropriate andapplicable where the quality of information matters. For theinformation to be considered, it should add up to the quality of workand the final reported to be written by the auditor. Qualitativemateriality involves matters that relates to non-adherence to setstandards of reporting, sensitive matters that caution thecredibility of the information provided. When the auditor is takinginto consideration qualitative factors the following accounts aremostly involved severance charges, suspense account, and cash.Qualitative factors are also considered to determine whether thereare low-risk accounts material misstatements that are qualitativedespite the account being large. For instance in our consolidatedbalance sheet of Sarbox scooters the auditor may consider pickingitems that may look too small but are a qualitative factor. The cashand cash equivalents, the marketable securities and current portionof finance receivables.
Quantitativefactors in materiality
Takinginto consideration quantitative factors, the auditor considers theaccounts that contain more information. The materiality here ismeasure depending on the quantity of misstatements realized. Thus, wemay refer to all other accounts quantitative significant apart fromthe cash and each equivalent, the severance charges account and thesuspense account.
Ways of identifying significant locations
Companieshave different policies for identifying significant locations in theaccounts. The Sarbox Company apply the following units: Theindividual locations of relevance, that consist of specific riskcreates a significance misstatement in the consolidated financialsaccounts of the company and locations that when consolidated couldrepresent a level of financial significance that could create amaterial misstatement in the consolidated financial statements. Thespecific metrics identified by Delmoss Watergrant provided a clearway of determining significant locations. Using the data provided bySarbox Company, the significant location can be obtained as 10% ofthe net income and the total assets as described by the metrics. Thisis as shown below
Metric1 Units/location > $38,480
Metric2 Units/location > $342,207
Thisimplies that, any misstatement greater than this locations isconsidered as significant.
How adequate coverage of significant accounts is achieved
Theadequate coverage of significant accounts may not necessarily beachieved through covering the significant locations. This is becausethere may be significant information outside this scope hence anothernon-significance information is not reviewed the information may notbe covered. In this case, most of the significant account haveattained at least 50% of the consolidated balances. There is also theimportance of the auditor testing the prepaid expenses and othercurrent assets due to their significance in the financial statements.Even though this coverage test may result in a number of situations,the auditor ought to develop an audit plan to obtain sufficientcoverage.
4)Identification and testing of Entity-level controls
AS5.24There are two major entity level controls they include the controlsrelated to control environment and then secondly we have the controlover management override. Control over management is much essentialwhen it comes to internal control over financial reporting across thecompanies (Alvin, Elder & Beasley, 2010). The senior managementundertakes the control by monitoring and ensuring that the financialstatements have been prepared according to the reporting standardsand the company’s policies. The auditor is therefore, required toseek supportive evidence of the effectiveness of the internalcontrols with an attempt at addressing the risk of misstatement.
Definition of terms
Significantdeficiencythese refer to a collection of misstatements or collections ofdeficiencies that are less material and may not be considered thateffective though they cause significance changes in the finalstatements.
Materialweaknessrefers to a collection of deficiencies that have to the opinion ofthe auditor causes or may cause material misstatement on thecompany’s annual accounts.
Controldeficiencyrefers to misstatements or which are very insignificance that they donot cause material misstatements in the annual accounts.
Identifying the type of deficiency in the case.
a)This is a control deficiency because despite the misstatement ofinventory the figure is not easily noted at the end stockinventories. That is, and the deficiency exists but it’simmaterial. It is also not very possible to note such deficiencies inthe final accounts as they are not material. The misstatement is $2.3million while the materiality was set at $2.35million and thereforethis deficiency confirms to be less than 10% that is the materialitylevel as per the Delmoss Watergrant’s policy. However, on notice ofsuch deficiency, the auditor should inquire more information thoughnot dedicate much of his time to such misstatement.
b)Following the narrated misstatement, this is a significancedeficiency as it involves a collection deficiency in the varioustransactions that were carried out. These include non-routine salesrecords that were not well captured, the terms of sale were also notwell adhered to. These misstatements seems too tiny to causevariances in the final statements. Given that the materiality of themisstatement is at 10% them this will cause some observable changesin the final annual accounts of the company.
c)Under this scenario, the deficiency will be considered a materialweakness. This is because the error cause will be very material giventhat it occurs during the high peak season of sales. Out of the manysales transactions conducted with an error, there will be collectionsof error which will create a huge variance at the end. Also themeasures which are being taken to make corrections or control of thisdeficiency are not detailed to make changes or reduce the materialityof the misstatements cause in the annual books of accounts.
AlvinA., Elder J. and Beasley S. (2010). Auditing and Assurance Services14thEdition. Upper Saddle River: London