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CHAPTER 8 MATERIALITY DECISIONS AND PERFORMING ANALYTICAL PROCEDURES

8-14. a. The following discussion first evaluates each potential misstatement individually. 1. Title did not pass on these two shipments until January 20x . !ence" revenue should not have #een recogni$ed. %ecause the auditor audited every transaction during the cutoff period" sampling is not involved. The following &ournal entry represents the &ournal entry needed to correct the potential misstatement. 'evenue )nventory +ccounts 'eceiva#le ,ost of -oods .old (240"000 (1*0"000 (240"000 (1*0"000

2. )nventory has not #een recorded at the lower of cost or mar/et. The potential magnitude of the misstatement would #e to mar/ inventory on the #oo/s at (*0 "000 down to (11 "000. ,ost of -oods .old )nventory (220"000 (220"000

*. These two transactions represent unrecorded lia#ilities. Title was received in each transaction prior to year-end. The following &ournal entry represents the &ournal entry needed to correct the potential misstatement. )nventory 2ixed +ssets +ccounts 3aya#le (200"000 (1 0"000 (* 0"000

a.%-(&))* + $//)()))* . This is a pro#lem in the construction industry. The following analysis considers the aggregate impact of these misstatements on the financial statements.))())) + %&)())) + /&)())) + $%/)()))* + %&)())) + /&)())) + + $.)()))* )n aggregate" accounts receiva#le is overstated #y (240"000 5tolera#le misstatement is (260"0007" inventory is understated #y (110"000 5tolera#le misstatement is (2 0"0007" accounts paya#le is understated #y (* 0"000 5tolera#le misstatement is (240"0007" pretax income is overstated #y (**0"000 5tolera#le misstatement is (61 "0007. Current Assets Noncurrent Liabilities Stockholders' Current Noncurrent Equity + + + %/)())) $. The fact that inventory turn days is speeding up for .. 8-1 . +ccounts paya#le should #e ad&usted and since changes are #eing made to the financial statements the auditor might propose ma/ing ad&ustments for all /nown misstatements. +ccounts paya#le is materially misstated" and misstatements in accounts receiva#le approaches tolera#le misstatement. )t assumes a * 4 tax rate.-)()))* $%-/()))* + $.. This outcome from analytical procedures should influence the auditor9s assessment of fraud ris/" and the auditor should consider that there is a high ris/ that inventory might #e misstated due to misappropriation of assets. 8-16. .-(&)) + %/)())) Pre-tax Earnin s Account "e#enue In#entory Accounts "ecei#able Cost o0 1oods Sold Cost o0 1oods Sold In#entory In#entory 3ixed Assets Accounts Payable A re ate 4isstatements $%&'()))* + $.onstruction )ndustry 'esources" )nc. This fact" com#ined with the fact that gross margins are declining may #e an indication of inventory shrin/age 8 or the possi#le theft of inventory. The following ta#le calculates purchases" gross margin percentage" inventory turn days" accounts receiva#le turn days" accounts paya#le turn days" and the gross and net operating cycle.#.-)()))* + + + + $.)()))* . may #e an indicator that inventory is understated.

24 100 0 204 4* 2 1 )nventory Turn .ycle +ccounts 3aya#le Turn . This is potential evidence of an overstatement of inventory that might #e due to either an error in counting or calculating inventory or due to fraudulent financial reporting. .14 18 01 282 1 2*1 1"821 ( 2.ales .ales 20x4 ( ( ( ( ( ( 062 1"00* 201 4"022 1"02* 2"000 ( ( ( ( ( ( 20x 822 1"021 11 *"00 1"8 0 2"046 1"88* 2. )n order to turn tolera#le misstatement into inventory turn days the auditor would use the formula for calculating inventory turn days as follows> Tolera#le :isstatement ? .ost of .ays =et <perating .old @ *6 A 4 ? 1"8 0 @ *6 A 1. The most significant changes in 20x are the com#ined decrease in purchases and increase in gross margin" increasing to 2.84 days c. )mportant trends for 20x 5the li/ely year a#out to #e audited7 include the significant increase in inventory turn days" the increase in gross margin to the #est result in the four year period" and the improved collection period.*4 160 10 2*0 ** 101 2"111 ( 48.ost of -oods .Exhibit 8-16: CTI Selectied Financial Information ($000) 20x1 20x2 20x* +ccounts 'eceiva#le" net )nventory +ccounts 3aya#le .44" while inventory turn days also increases significantly" increasing to 100 days. The increase from 18* day inventory turn to 100 day inventory turn is significant given the results in part c a#ove.ays -ross <perating . d.ycle #.ays +ccounts 'eceiva#le Turn .44 100 8* 28* *6 246 ( ( ( ( ( ( 8*1 1"02 164 *"180 1"812 1"068 ( ( ( ( ( ( ( 1"** 1"*21 *80 "6*8 2"601 2"041 ( ( ( ( ( ( 1"121 1"000 22 4"62* 2"*00 2"224 -ross :argin 3urchases -ross :argin 2"00* ( 2.