5. Presented below are three different transactions related to materiality. Expl

Question

5. Presented below are three different transactions related to materiality. Explain whether you would classify the transaction as material and why you would/would not do so.

a. A company reported a positive trend in earnings over the last 3 years. In the current year it reduces its bad debt allowance and the related bad debt expense to ensure another positive earnings year. The impact of this adjustment is equal to 3% of net income. Material/Not Material_____________________________________________________________

Rationale: ______________________________________________________________________ _______________________________________________________________________________ _______________________________________________________________________________

b. A company has an unusual gain of $3.1 million on the sale of plant assets and a $3.3 million loss on the sale of investments. Management decides to net the gain and loss because the net effect is considered immaterial. The company’s net income for the current year was $10 million. Material/Not Material_____________________________________________________________

Rationale: ______________________________________________________________________ _______________________________________________________________________________ _______________________________________________________________________________

c. A company expenses all capital equipment under $25,000 on the basis that it is immaterial. Management has followed this practice for a number of years. Material/Not Material_____________________________________________________________

Rationale: ______________________________________________________________________ _______________________________________________________________________________ _______________________________________________________________________________

Explanation / Answer

(a). Material

Explanation;

This is material because given change shows a positive trend in earnings. As it is given that company reported a positive trend in earnings, apart from this reduction in bad debt allowance and bad debt expense also shows positive trend hence it is material for the company.

(b). Not material

Explanation;

Each item need to be reported separately hence can not be netted. So each item is separately material.

As it is given in the question that management decided to net both separate transaction that is why as per rule each transaction should be reported separately and both transaction are separately material.

(c). Not material

If a company accept some capital expenses immaterial which are below a certain amount then it will not be treated as violation of the materiality concept because such same practice followed from year to year. So company recognisition of such capital expenses as immaterial is acceptable.

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