Case Study: Argo Co. Part 1
Determining Materiality Thresholds
The audit firm of DCG, LLP is performing an audit of Argo Co., a publicly traded company, for the year ended December 31, 2020. You have been given the assignment of assisting in the planning process for the audit by determining appropriate benchmarks and percentages to be used for overall planning materiality and for performance materiality. You have also been tasked with evaluating audit evidence upon completion of audit procedures to determine whether or not projected misstatements are deemed to be material.
In researching your firm’s guidance on establishing overall planning and performance materiality (see the “Argo Co. DGC Policies and Procedures” document), you learn that both quantitative and qualitative factors should be considered in materiality judgments. As such, you perform some preliminary research and identify the following qualitative factors that may be relevant to your materiality judgments:
- Argo’s Vice President of Sales (VP-Sales) earns a $50,000 bonus if Argo’s 2020 sales are at least $25,120,000.
- The analyst’s consensus forecast for Argo’s 2020 pre-tax income is $6,050,500.
- In the audit of the 2019 financial statements, Argo’s external auditors determined that a material weakness in internal controls existed with relation to controls over land acquisitions and disposals.
Since the determination of overall planning materiality occurs before year end, DCG has computed projections of key financial statement balances for the purpose of determining overall planning materiality. The computed projections, as well as prior-year actual balances, are as follows:
| Account | 12/31/2020 Balance (projected) | 12/31/2019 Balance (audited) | 12/31/2018 Balance (audited) |
|---|---|---|---|
| Sales | $25,354,128 | $22,122,039 | $23,346,943 |
| Total Assets | $19,885,320 | $17,336,809 | $18,204,143 |
| Gross Profit | $12,409,357 | $10,819,457 | $11,236,851 |
| Pre-Tax Income | $6,423,040 | $5,615,674 | $5,881,853 |
| Due Date: | Feb 08 at 23:00 |
| Points: | 2 |
Resource Files:2 files
Argo+Co.+DCG+Policies+and+Procedures+document.pdf
Argo Co. Materiality Workpapers.xlsx
Started on Feb 08 at 02:24
Your Submission:
- Bookmark question for laterRequirement #1:Review DCG’s policies and procedures pertaining to overall planning and performance materiality. The firm’s guidance is found in a file attached to this case (Argo Co. DCG Policies and Procedures document.pdf).Requirement #2:Using information from the case and from the DCG Policies and Procedures file, complete Work Paper (WP) 2-1 in the attached Excel file (Argo Co. Materiality Workpapers.xlsx) to document your calculation of overall planning materiality for the engagement. The work paper serves an important documentation role; as such, make sure to perform each of the following steps:a. Identify and select the most appropriate financial statement benchmark for establishing overall planning materiality. Briefly justify your selection in the text box provided.b. Select and document an appropriate materiality factor (percentage) for determining overall planning materiality. Briefly justify your selection in the text box provided in the work paper.c. Verify the accuracy and appropriateness of the Computed Overall Planning Materiality for the engagement. Record your initials in the heading of the work paper to establish responsibility for the work paper and its contents. Requirement #3:Using your calculations from the previous tasks and the guidance in DCG’s Policies and Procedures document, complete Work Paper (WP) 2-2 to document the maximum threshold for performance materiality and to determine appropriate levels of performance materiality to be applied to each of the listed accounts. Ensure that you complete each of the following steps:a. Select and document an appropriate performance materiality factor for each of the listed accounts. Justify your selections for each account in the provided text boxes. b. Verify the accuracy and appropriateness of the Total Performance Materiality Assigned. Record your initials in the heading of the work paper to establish responsibility for the work paper and its contents. Upload the completed spreadsheet here.
1 Select File… Please upload 1 file(s).
- Bookmark question for laterRefer to the Total Performance Materiality Assigned in WP 2-2. Explain why the auditor would allocate more than the Computed Overall Planning Materiality amount (see WP 2-1) to the set of financial statement accounts. In other words, why would auditors permit the Total Performance Materiality Allocated amount to be greater than the Computed Overall Planning Materiality amount?
Case Study: Argo Co. Part 2
Based on their testing, the audit team concluded that the total projected misstatements are as follows:
- Sales: $235,506
- Cash: $258,046
- Land: $173,338
The cash misstatement amount is based on the result of a cash confirmation from a bank that was $258,046 less than the reported client balance. The misstatement in the Land account resulted from Argo's failure to remove the land from its books after donating it to charity. The Summary of Discovered Misstatements table below shows three sales transactions that contain misstatements.
| Summary of Discovered Misstatements (Sales Account) | ||||
|---|---|---|---|---|
| Selection Number | Reported Sale Amount | Audited Sale Amount | Misstatement | Notes |
| 5 | $86,178.46 | $68,178.46 | $18,000 | Transposition error |
| 17 | $217,934.70 | $0 | $217,934.70 | Recorded in wrong accounting period |
| 21 | $135,476.94 | $135,905.64 | $(428.70) | Incorrect amount recorded |
| Total Misstatement | $235,506.00 |
| Due Date: | Feb 08 at 23:00 |
| Points: | 3 |
Started on Feb 08 at 02:31
Your Submission:
- Bookmark question for laterAssume the audit engagement team determined performance materiality to be $240,864 for each account above (note that this amount will likely not agree with the amounts you determined above). Evaluate each misstatement listed above at the financial statement account level to determine whether or not each would be considered material. Explain your rationale for each misstatement.◢
- Bookmark question for laterRefer to the Summary of Discovered Misstatements (Sales Account) table above. Notice that some identified misstatements caused Sales to be overstated while another caused the same account to be understated. How do you think an auditor should treat offsetting misstatements like this when evaluating the materiality of misstatements within an account and for the overall financial statements? To see what guidance auditors receive from the standards, see AU-C 450.A26, AS 2810.B2, and ISA 450.A14.◢
- Bookmark question for laterAssume that circumstances caused your audit team to suspect the overstatement of the Cash account in this example was intentional. Would this fact influence your judgment regarding the materiality of the Cash misstatement? How else might this information affect the audit engagement?
