The accounting firm of Brooke & Doggett, CPAs, recently completed the audits of

Question

The accounting firm of Brooke & Doggett, CPAs, recently completed the audits of three separate companies. During these audits, the following events were discovered, and Brooke & Doggett is trying to decide if each event is material. If an item is material, the CPA firm will insist that the company modify the financial statements.

In 2016, Major Company reported service revenues of $1,000,000 and earnings before tax of $80,000. Because of an accounting error, the company recorded $6,000 as revenue in 2016 for services that will not be performed until early 2017.

Willis Company plans to report a cash balance of $70,000. Because of an accounting error, this amount is $5,000 too high. Willis also plans to report total assets of $4,000,000 and net earnings of $415,000.

Adams Company’s 2016 balance sheet shows a cash balance of $200,000 and total assets of $9,000,000. For 2016, the company had a net income of $750,000. These balances are all correct, but they would have been $5,000 higher if the president of the company had not claimed business travel expenses that were, in fact, the cost of personal vacations for him and his family. He charged the costs of these trips on the company’s credit card. The president of Adams Company owns 25 percent of the business.

Required Write a memorandum to the partners of Brooke & Doggett, explaining whether each of these events is material.

Explanation / Answer

Let’ understand the concept of materiality: The materiality principle states that an accounting standard can be ignored if the net impact of doing so has such a small impact on the financial statements that a reader of the financial statements would not be misled.

Under generally accepted accounting principles (GAAP), you do not have to implement the provisions of an accounting standard if an item is immaterial. This definition does not provide definitive guidance in distinguishing material information from immaterial information, so it is necessary to exercise judgment in deciding if a transaction is material.

a.

The effect of revenue is 0.8% and on profit it we take on pro-rata basis is 6000*.8%=$48 which is immaterial, so CPA firm will not insist that the company modify the financial statements.

b.

The improper recording of liquid asset is a serious default, which shows that internal control within the organization does not exist or improper. In addition to it is 1.625% (65000/4000000) of the total assets and effect on the profit assumed all other assets and liabilities are recorded properly is also 1.625%, so it material CPA firm will insist that the company modify the financial statements, if that company does not change the data CPA must qualify the financial report.

c.

Since the personal expenses of the president who have 25% control in the business has been debited to the P&L account even amount is small but act is material so it material CPA firm will insist that the company modify the financial statements, if that company does not change the data CPA must qualify the financial report

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