Panzero Bread is a major retailer of specialty sandwich items and baked goods. T
ID: 2422777 • Letter: P
Question
Panzero Bread is a major retailer of specialty sandwich items and baked goods. The following information represents the com- pany’s financial position as of 12/31/14 and 12/31/13. 12/31/14 (unaudited) 12/31/13 (audited) Total assets $698,752,000 $542,609,000 Accounts receivable $25,152,000 $19,041,000 Total sales $1,066,691,000 $828,971,000 Cost of goods sold $842,255,000 $628,534,000 Net income $57,456,000 $58,849,000 Earnings per share $1.81 $1.88 The auditor of Panzero Bread identifies the company as a client with high audit risk and has set the posting thresholds for individ- ual accounts at 10% of overall financial statement materiality levels. The auditors have detected an overstatement of accounts receivable of $345,000. The misstatement is not a surprise to the auditors, as they have detected misstatements in this account in the past. On a per share basis, the misstatement represents $0.01 of earnings per share. The auditor believes that the misstatement should be corrected. Management argues strongly that they prefer not to make the correction because they do not believe it is mate- rial; that is, the misstatement represents just over 1% of the account balance. Although left unsaid, the auditor knows that management is under considerable pressure from Wall Street to meet analyst expectations for earnings per share. Reducing earnings per share by even $0.01 would cause the trend in earnings to become even more negative than the unaudited financial numbers already reveal, and it would cause the company to just miss analyst forecasts for earnings per share. a. Use the three common benchmarks for making materiality judgments (net income, total assets, and net sales) to establish materiality for the financial statements overall. b. What difficulties does the auditor face when the alternative benchmarks yield differing conclusions about materiality? What qualitative factors should the auditor consider in making its materiality judgment in that case? c. Articulate a reason for choosing one particular benchmark among the three calculated in part (a), and use that benchmark to calculate the posting (clearly trivial) threshold for the accounts receivable account. d. What effect will the qualitative factors in this case have on the auditor’s posting (clearly trivial) threshold for the accounts receivable account?
Explanation / Answer
12/31/14 12/31/13
Total assets $ 698,752,000 $ 542,609,000
Accounts Receivables 25,152,000 19,001,000
Total sales 1,066,691,000 828,971,000
Cost of goods sold 842,456,000 628,,534,000
Net Income 57,456,000 58,849,000
Eanings per share 1.81 1.88
(a) Three common Bench marks are used to decide whether a mistatement is material or not are as follows: :
(i) Net Income : If net income is mis-stated, such mis-statement value is less than 5%, that mis-statement is not
material.
(ii) Accounts receivables: If accounts receivabel mis-statement is less than 1%, lhat is not material mis-statement
(iii) Nets Sales: If material mis-statement of net sales is less than 1%, that is not material mis-statement.
b. When the auditor use different alternative bench marks, he generally face dificulties in giving correct openior on the financial statements, materiality depends on the size of the orgnanization, for eg. material mistatement of $5000 in account balance is not a material issue to a big firm, but is material for a small firm, If he use different alternatives, he persists audit risk.
In such case, he has to make use of his professional experience and judgement. And he also has to consider the size of organisation also. Apart from quantitative factors, he has to consider the qualitative factors like
* mis-statements due to fraud or illegal act
* Amounts that mayviolate contractual covenents
* Amounts that may affect earnings trends
* Mis-stttements that may increase managment compensation
* Past number of mis-statements
c. Selection of a particualar benchmark is based on business nature, here Panzero Bread is the business of retail business. It is better to calculate benchmark based on Net sales. Overstatement of accounts receivables i.e 3,45,000 is less than 1% of sales, it shoud be ignored based on the variability is trivial, but the comapany repeatedly doing this overstatement of accounts receivables, the auditor shoudl not accept this overstatement and auditor should ask management to rectify the balance of accounts receivables. If management is not rectify, the auditor shoud qualify its audit report.
d. Overstatement of accounts receivables may increase the liquidity position of a company or overall solvency may increase. The management may do it in further years also. As accouns receivables are overstated, the sales of 2014 are also overstated, which leads to higher net income, which may leads to increae the management remuneration as generally it is to be given on net profit. It also has affect on bonus to employees
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