Question

Jacob, CPA, of Great CPA is auditing the Year 6 financial statements for PB Copiers Company, an issuer. PB Copiers Company currently offers three models of its copy machine: Model A, for personal use ($400); Model B, for small businesses ($1,000); and Model C, for large businesses ($3,000).

Jacob has set performance materiality at $20,000.

Management has provided Jacob with the following list of related parties:

• Aaron Wolf

• Barbara Chen

• Chris Johnson

• Copier Rentals

• Debbie Anderson

• Rental Business Machines­–Los Angeles

• Jenna Gerstner

• Juan Garcia

• Sarah Noodle

INFO:

PB Copiers Company-Organizational Charts Entity Organizational Chart PB Copiers Rental Business Machines-Los Angeles (40% ownership) Copier Rentals (35% ownership) PB Copiers Company Organizational Chart PB Copiers Company Board of Directors Aaron Wolf, CEO Sarah Noodle, CFO Jenna Gerstner, sales operations manager Gavin Stone, sales representative Tracy Wang, sales representative Kandice Szafarski, accounting clerk

Minutes From Special Meeting

PB Copiers Company

Minutes of special meeting of June 25, Year 6

Members present: Aaron Wolf

Barbara Chen

Chris Johnson

Debbie Anderson

Juan Garcia

Not present: N/A

Agenda item: Conversion of debt to equity and purchase of office building

This special meeting of the Board of Directors has been called to discuss conversion of debt to equity and purchase of an office building.

PB Copiers has an outstanding loan balance with Jenna Gerstner for $80,000. She has agreed to convert this entire debt to equity in PB Copiers valued at $100,000.

Management has located an office building that meets the current needs of our growing business. The office building is owned by Sarah Noodle. She is willing to sell the building for $300,000 (fair market value of the building is $300,000).

Action: Conversion of debt to equity approved to Jenna Gerstner as designated above. Purchase of office building for $300,000 approved with an escrow close date of August 15, Year 6.

E-mail From CFO

From: [email protected]

Sent: January 10, Year 7, 2:15 p.m.

To: [email protected]

Subject: RE: Sales Near Year-End

Hi Jacob:

This e-mail is in response to your question regarding the sales transactions with related parties.

We provide all our employees a 10 percent discount on the purchase of copy machines.

We usually sell about 50 copiers a day. On December 31, Year 6, we sold 300 copiers to Don Nichols. We were very excited about this bulk sale—it helped us beat and exceed our annual goal.

Please let me know if you need any additional information.

Thank you,

Sarah Noodle

CFO

Questions:

Answer 1

Related Party Transaction:

A Related Party Transaction is a transaction that takes place between two parties who hold a pre-existing connection prior to the transaction.

Materiality level:

The level of amount set by the auditor so that any transaction or any deviation which exceeds the materiality limit may be treated as important and will be further dealt with in.

Performance materiality :

Performance materiality is also a materiality level but it is an amount which is less than actual materiality level. It is actually set by the auditor to find the deviations that fall below the actual materiality level so that maximum deviations will be found by the auditor.

Arms length Transaction:

An arm's length transaction refers to a business deal in which buyers & sellers act independently without one party influncing the other. It means both the buyer & seller have adequate knowledge about the price of the product & the situation of the market.

S.no	Related party Transaction	Effect on the risk of material misstatement.
1	Transaction with Rental Business Machines LA regarding sale of model C for $6000	There is no effect on the risk of material misstatement since the article was sold at an arms length price to Rental Business Machines LA i.e.,$6000.($3000*2)
2	Transaction with Aaron wolf regarding sale of Model A for $360	The risk of material misstatement increases because the model A was sold to Aaron wolf who is a related party at the rate of $360 where the actual sale price is $400. But it doesn't effect the financial statements & the auditor's opinion materially because the performance materiality set by Jacob is $20000. Since the sale price is less than $20000, it can be treated as immaterial but it should be disclosed properly in the financial statements.
3	Conversion of an outstanding loan balance valued $80,000 with Jenna Gerstner into an equity valued $1,00,000.	The effect of the risk of material misstatement increases because the agreed value of the outstanding loan balance of Jenna Gerstner is more than the actual loan amount. So this conversion of loan amount into equity of value $1,00,000 was not an arms length transaction. So it might significantly influence the decisions of the users of the Financial statements. And also the difference of the loan & agreed equity equals to $20,000($1,00,000-$80,000) which is equivalent to the performance materiality set by Jacob, so it will definitely increases the risk of material misstatement & also negatively effect the auditor's opinion.
4	Purchase of office building from Sarah Noodle for a value of $3,00,000, the market value of which is $3,00,000.	There will be no effect on the risk of material misstatement due to this transaction because it is clearly an arms length transaction between PB copiers & Sarah Noodle since the fair value & sale value of the office building are same.