AAA – Nov 2017 – L3 – Q1a – Planning, Audit Evidence

Analyze the materiality of management's plans to discontinue sales of ladies wear and the provision for redundant employees.

Question

The draft accounts of your client Good Days Ltd., a shopping mall for the year ended 31 December 2016 showed the following:

	2016 (GH¢ million)	2015 (GH¢ million)
Revenue	84.40	83.60
Profit before tax	5.00	4.40
Total Assets	75.00	46.80

In December 2016, management announced plans to stop the sales of ladies wear from the end of the month. These sales amounted to GH¢1.4 million for the year ended 31 December 2016 (2015 GH¢1.6 million). A provision of GH¢0.6 million has been made at 31 December 2016 for the compensation of redundant employees who are mainly sales girls.

Required:
Comment on the materiality of these two plans.

Note: The following materiality levels are to be used as benchmarks:

Value	%
Profit Before Tax	5
Gross Profit	½ – 1
Revenue	½ – 1
Total Assets	1 – 2
Net Assets	2 – 5
Profit After Tax	5 – 12

Answer

Ladies Wear:
- Revenue from the ladies wear forms part of the total revenue of the company. The relevant indicator of materiality is therefore revenue.
- The ladies wear revenue as a percentage of total revenue is as follows:
  - $GH¢1.4 \times 100 \div 84.40 = 1.66\%$
  - 1.66% is higher than the materiality threshold of ½ -1% of revenue. Therefore, the ladies wear sales revenue is material to the statements of Profit or Loss and other comprehensive income.
- Marks: 4
Provision:
- The provision should be considered in terms of its effect on the financial statements. It affects both the statement of financial position as it’s a liability in the financial statements and the statement of profit or loss and other comprehensive income as it is a charge in arriving at the profit or loss for the year.
- Statement of Financial Position:
  - $GH¢0.6m \times 100 \div 75m = 0.8\%$ of total assets.
  - The materiality threshold for total assets is 1-2% therefore the 0.8% is not material to the statement of financial position.
  - Marks: 3
- Statement of Profit or Loss and Other Comprehensive Income:
  - $GH¢0.6m \times 100 \div 5m = 12\%$ .
  - The materiality threshold for profit before tax is 5% therefore the 12% is material to the statements of profit or loss and other comprehensive income. Marks: 3

Tags: Financial Statements, Materiality, Provision, Revenue
Level: Level 3

Topic: Audit evidence, Planning
Series: NOV 2017

Uploader: Dotse