Question

Cloud 9 Ltd. Case Book Assignment 2.1 a (Essay)

Planning materiality

W&S Partners’ audit methodology dictates that one planning materiality (PM) amount is to be used for the financial statements as a whole. Further, only one basis should be selected—a blended approach or average should not be used. The basis selected is the one determined to be the key driver of the business.

W&S Partners uses the following percentages as starting points for the various bases. These starting points can be increased or decreased by taking into account qualitative client factors, which could be:

?		the nature of the client’s business and industry (such as rapid change, either through growth or downsizing, or unstable environment)
?		the fact that it is a publicly listed entity (or subsidiary of) subject to regulations
?		the knowledge of or high risk of fraud.

Base		Threshold (%)
Profit before tax		5.0
Revenues		0.5
Gross profit		2.0
Total assets		0.5
Equity		1.0

Typically, profit before tax is used; however, it cannot be used if the entity is reporting a loss for the year or if profitability is not consistent.

When calculating PM based on interim figures, it may be necessary to annualize the results. This allows the auditor to properly plan the audit based on an approximate projected year-end balance. Then, at year end, the figure is adjusted, if necessary, to reflect the actual results.

Note: Adjustments to the starting points are made by an experienced auditor using their professional judgement. The aim is to set PM at a high enough level that appropriately balances the amount of testing, while still keeping the audit risk to an acceptable level.

Performance materiality

W&S Partners also dictates that performance materiality be determined for each audit engagement. Performance materiality is an amount less than planning materiality that reduces the likelihood that any uncorrected and undetected misstatements within a class of transactions, account balances, or disclosures in aggregate exceed overall planning materiality. W&S Partners’ policy is to use 70 percent of planning materiality to determine performance materiality.



(a)

Using the working paper provided above, select the basis for planning materiality that you believe is most appropriate. Justify your selection. How would the planning materiality be used? What would lead the auditor to increase or decrease materiality?

Answer 1

The basis to be selected in this audit should be Profit before Tax and Revenues. As the organization has taken a loan from the bank, so the bank would be interested in the profit making capacity and consistency of profits and for more profit, there should be more revenues and the management is also interested in the revenues amount.

Planning Materiality is the amount of transactions which the auditor will audit and check whether the involved transactions shows true and fair view of the financial statements. Materiality depends on various factors such as Auditor’s Experience in previous audits, internal control of the organization, etc.

If the auditor observes that the internal control is not up to mark or some other factors like management interferences in day to day working, etc., then the auditor will decrease the materiality limit so that transactions involving lower amount will also be covered in the audit, so that more transactions can be checked. If the auditor observes that everything is going good in the organization, then they may increase the materiality limit.