Chapter 9 Materiality and Risk - HCC Learning Web

9-37 (continued)9. Inherent Risk: An ongoing dispute with the Internal RevenueService may require an adjustment to income tax liability or adisclosure in footnotes for a contingency, depending on thestatus of the dispute.Accounts Affected: Income tax expense and income taxespayable10. Inherent Risk: This situation involves a related partytransaction (Solar-Electro borrowed money from theWelburn division). Because this transaction was not conductedwith an outside party, it is possible that the related receivableand payable might not have been properly eliminated onPinnacle’s consolidated financial statements.Accounts Affected: Notes payable, notes receivable, interestexpense and interest income.11. Inherent Risk: This situation involves a nonroutine transactionwhere there is a risk that materials, labor and/or overheadare incorrectly applied to the property accounts.Accounts Affected: Property accounts, inventory and cost ofsales.■ Internet Problem Solution: Materiality and Tolerable Misstatement9-1 Establishing materiality for the audit of a client’s financial statement requiresconsiderable judgment. The allocation of the auditor’s preliminary judgmentabout materiality to the client’s accounts requires substantial judgment as well.For this reason, decisions about materiality are made by more experiencedauditors. The following problem affords you an opportunity to apply the conceptof materiality to an actual set of financial statements.1. Imagine that you are employed as an auditor in a CPA firm thatperforms the audit of Microsoft. Your firm’s materiality guidelinesindicate that overall engagement materiality should be set at anamount between five and ten percent of income before taxes.a. Apply your firm’s guidelines to Microsoft’s 2008 financialstatements. What percentage of income before taxes do youbelieve is appropriate? Why? What do you believe overallengagement materiality should have been for 2008?9-24