- 20 Marks
Question
Holy Family Limited is a trading company that deals in furniture. The company is a major distributor to Happy Couples Limited that manufactures the furniture. The turnover of the company as at December 31, 2017, was ₦120,000,000. Also, in the statement of financial position is a figure of ₦2,500,000 that represents trade receivables. The auditor informs the Managing Director of the need to circularize the debtors. The Managing Director feels indifferent to circularization, saying that the figure of ₦2,500,000 is not material with a turnover of ₦120,000,000.
Required:
a. As an auditor, explain to the Managing Director the concept of materiality in accordance with ISA 320.
(5 Marks)
b. State the steps you are expected to take as regards materiality when planning and performing an audit.
(5 Marks)
c. Explain to him why you should confirm receivable balances through circularization.
(3 Marks)
d. If you decide to circularize only a sample of receivables, list the types of accounts that should not be overlooked in selecting the sample.
(7 Marks)
Answer
(a) Explanation of the concept of materiality in accordance with ISA 320
The auditor provides an opinion on whether the financial statements present fairly, in all material respects, the financial position and performance of the entity. Information is considered material if its omission or misstatement could influence the economic decisions of users based on the financial statements. By applying the concept of materiality, the auditor focuses on significant items that could lead to material misstatements.
(b) Steps regarding materiality when planning and performing an audit
In assessing materiality, auditors assume that users of financial statements:
- Have reasonable knowledge of business and financial statements.
- Understand that financial statements are prepared with materiality thresholds.
- Recognize uncertainties in certain figures (e.g., provisions).
- Make reasonable economic decisions based on the financial information.
- Apply ISA 320 when evaluating misstatements and their potential effect on the audit opinion.
(c) Why confirm receivable balances through circularization
Confirming receivable balances provides external, independent evidence about the existence and valuation of a company’s assets. This external confirmation is often more reliable than internal records because it offers independent verification that the customer owes the amount stated in the company’s financial statements.
(d) Types of accounts that should not be overlooked when selecting samples for circularization
- Nil balances.
- Credit or negative balances.
- Overdue balances.
- Balances in dispute.
- Accounts without specific invoices (round sum payments).
- Large or material balances.
- Related party balances.
- Accounts written off during the period
- Tags: Audit Planning, Circularization, ISA 320, Materiality, Receivables
- Level: Level 2
- Uploader: Kwame Aikins