EarthWear Hands-on Mini-case

Chapter 3 - Materiality and Tolerable Misstatement

The McGraw-Hill Companies, Inc., 202
INSTRUCTIONS:
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2
!ields yo" are to complete on wor# papers are colored yellow. The color will disappear when the $ield is completed.
3
!ields yo" are to complete on wor# papers are colored yellow. The color will disappear when the $ield is completed.
4
5
In this mini-case yo" will determine plannin% materiality as well as tolerable misstatement amo"nts
$or balance sheet acco"nts o$ &arth'ear Clothiers, Inc. 'hile many a"ditin% $irms "se a simple
approach $or establishin% plannin% materiality and tolerable misstatement similar to the one
ill"strated in yo"r te(tboo#, some $irms "se more detailed %"idelines that in)ol)e allocatin% a
m"ltiple o$ plannin% materiality to balance sheet acco"nts. This case ill"strates one s"ch approach.
*ead the Materiality G"idelines $or 'illis + ,dams C-,s. To open the %"idelines doc"ment please
do"ble-clic# on the $ollowin% icon. , doc"ment will open in Microso$t 'ord.
!ollowin% the Materiality G"idelines $or 'illis + ,dams C-,s, complete all the $ields on 'or# -aper
3-. indicated in yellow /'or# -aper 3-. is $o"nd on the ne(t tab o$ this wor#sheet0. !or yo"r
con)enience, &arth'ear !inancial 1tatements ha)e been incl"ded in wor#sheet tabs a$ter the
wor#in% papers.
!ollowin% the Materiality G"idelines $or 'illis + ,dams C-,s, complete all the $ields on 'or# -aper
3-2 indicated in yellow.
'hen completed with the wor# papers, enter yo"r initials in the yellow bo( with title
3Initial Here".
-lease print hard copies o$ wor# papers 3-. and 3-2 $or s"bmission "nless yo"r instr"ctor re4"ests
an electronic s"bmission. The wor# papers are each $ormatted to $it on one pa%e.
Document
Name:
Class:
ERTHWER C!OTHIERS 3-.
"#annin$ Materia#it% Initial Here
&ece'(er 31) 2*12 052.5206
(In thousands)
Una+dited
1, -ench'ar. &ata 2*12
2*11
1ales 5 *e)en"e /1)*10)10* 7890,626
&(penses /522)153 796:,383
-re-ta( income /2*)154 739,.9.
C"rrent assets /231)31* 7208,089
C"rrent liabilities /12*)312 7:,2:2
Total assets /310)421 7328,898
Materiality 7,200
2, Esta(#ish "#annin$ Materia#it% !e4e#
Meas+re'ent -ase 2*)154
-re-ta( income
"ercenta$e 55#ied6 5,*7
"#annin$ Materia#it% /3)5*1
-ases and "ercenta$e Ran$es:
-ro$it ;riented &ntities
Pre-tax income 3 - .<=
Total Revenue > - <
Current Assets or Liabilities 2 - 9<
Total Assets > - <
!or "ublic com"anies# $% is t&"icall& the maximum.
?ot-$or--ro$it &ntities
Total Revenue > - 2<
Total 'x"enses > - 2<
M"t"al !"nd &ntities
(et Asset )alue > - <
3, 8+sti9%:S+55ort ;o+r !e4e# o9 "#annin$ Materia#it%
Meas+re'ent -ase:
"ercenta$e:
-lease "se this template in con@"nction with 'illis + ,dams Materiality
G"idelines. The materiality $actors pro)ided are %"idelines only and
sho"ld be "sed only as an aid as yo" "se pro$essional @"d%ment to
determine plannin% materiality.
1tate the $actors that yo" considered to determine the appropriate meas"rement base and percenta%e to determine
plannin% materiality.
'e chose to "se the -re-ta( ?et Income beca"se we determined that it was stable, predictable and representati)e. It
did not dramatically chan%e $rom pro$it to loss $rom year to year.
'e chose to "se 9 percent as the threshold $or materiality beca"se 9 percent is the amo"nt typically "sed by p"blicly
traded companies.
Name:
Class:
ERTHWER C!OTHIERS 3-2
##ocation o9 Materia#it%: To#era(#e Misstate'ents Initial Here
&ece'(er 31) 2*12 052.5206
(In thousands)
Plannin* +aterialit& ,rom -or. "a"er /-01 2/#$34
cco+nt Na'e 2*11
To#era(#e Misstate'ent E<5#anation
Cash and cash e4"i)alents 762,8.2 /20)350 7900 <
Easi#% 4eri9ied
*ecei)ables, net 72,2.9 /1)343 7200 8<
In)entory 722,33. /142)303 72,300 2<
-repaid ad)ertisin% 7,692 /1*)212 700 <
Re#ati4e#% #itt#e chan$e 9ro' 5rior %ear) not di99ic+#t to a+dit
;ther prepaid e(penses 7:,39 /5)435 7200 6<
Ae$erred income ta( bene$its 7.,32 /1*)331 7290 2<
Band and b"ildin%s 7.0,82 /23)53* 7.90 <
Relativel& little chan*e ,rom "rior &ear# not di,,icult to audit
!i(t"res and e4"ipment 7:.,93 /31)332 7.90 <
Relativel& little chan*e ,rom "rior &ear# not di,,icult to audit
Comp"ter hardware and so$tware 7:6,82: /25)4** 7,300 2<
Easi#% 4eri9ied) s+(=ect to i'5air'ent
Beasehold impro)ements 73,00 /3)144 760 <
Re#ati4e#% #itt#e chan$e 9ro' 5rior %ear) not di99ic+#t to a+dit
,cc"m"lated depreciation and amortiCation 729,82: /02)222 72,900 3<
Intan%ibles, net 7623 /1)234 7200 2<
Bines o$ credit 7,0 /1*)51* 7300 3<
Relativel& little volume# not di,,icult to audit via /rd "art& in,o
,cco"nts payable 7:2,908 /54)113 7,.00 3<
*eser)e $or ret"rns 79,280 /3)1** 7600 .<
,ccr"ed liabilities 72:,.32 /3*)402 7.00 2<
So'e>hat cost#% to a+dit) so'e di99erences e<5ected
,ccr"ed pro$it sharin% 7,932 /3)1*1 7200 :<
5ome-hat costl& to audit# some di,,erences ex"ected
Income ta(es payable 72,922 /13)222 7300 2<
Re#ati4e#% co'5#e<) esti'ation in4o#4ed
Ae$erred income ta(es 78,6:8 /1)345 7290 3<
Common stoc#, 2:,2 shares iss"ed 72: /231 70 0<
(o chan*e ,rom "rior &ear# easil& veri,ied
Aonated capital 79,6:0 /5)43* 70 0<
(o chan*e ,rom "rior &ear# easil& veri,ied
,dditional paid-in capital 720,.60 /25)210 7200 <
Little chan*e ,rom "rior &ear# not di,,icult to audit
Ae$erred compensation /7.80 ?/33@ 7 3<
(ot di,,icult to audit# examine current &ear vestin* activit&
,cc"m"lated other comprehensi)e income 73,223 /2)123 790 2<
Involves some com"lex a""lications o, 6AAP
*etained earnin%s 73.,80. /331)4*2 ?,
Treas"ry stoc#, :,96: and :,.0: shares at cost, respecti)ely /763,8900 ?/134)512@ 7200 0<
Little chan*e ,rom "rior &ear# not di,,icult to audit
Co'(ined To#era(#e Misstate'ent ?co#+'n 3@ /13)001 Combined Tolerable +isstatement 7ithin Acce"table Limits
Ma<i'+' ##o>a(#e Aor Co'(ined To#era(#e Misstate'ent6 /14)*31
Net Re'ainin$ ##o>ance Aor Co'(ined To#era(#e Misstate'ent /4*
The McGraw-Hill Companies, Inc., 202
2*12 Una+dited
Tria# -a#ance
"ercenta$e o9
cco+nt
!ar$e and co'5#e< acco+nt >ith 'isstate'ents e<5ected)
cost#% to a+dit
Lar*e and com"lex account -ith misstatements ex"ected# costl&
to audit
Relativel& routine accountin*# tested lar*el& via reasonableness
anal&tical "rocedures
Relativel& com"lex# estimation involved# related to 8e,erred
Income Taxes
cco+ntin$ esti'ate) tested #ar$e#% 4ia s+(stanti4e
ana#%tica# 5roced+re
In4o#4es so'e co'5#e< a55#ications o9 B") s+(=ect to
i'5air'ent
!ar$e and co'5#e< acco+nt >ith 'isstate'ents e<5ected)
cost#% to a+dit
Accountin* estimate# tested lar*el& via substantive anal&tical
"rocedure
Relativel& com"lex# estimation involved# related to 8e,erred
Income Tax 9ene,its
=!o"r Times -lannin% Materiality. In the te(tboo#, a more %eneral approach to allocate no more than .9< o$ plannin%
materiality to acco"nts as tolerable misstatement is $ollowed. Howe)er, as noted in the disc"ssion on materiality in
Chapter 3 o$ the te(t, some $irms do "se a m"ltiple approach. This mini-case "ses the m"ltiple approach to pro)ide
hands-on practice at allocatin% tolerable misstatement to acco"nts.
ERTHWER C!OTHIERS -
Conso#idated -a#ance Sheets PBC
(In thousands) 2535202
Aecember 3
ssets
2*11 2*1*
C+rrent ssets:
Cash and cash e4"i)alents /20)350 762,8.2 768,::2
*ecei)ables, net /1)343 72,2.9 7,938
In)entory /142)303 722,33. 709,629
-repaid ad)ertisin% /1*)212 7,692 70,..2
;ther prepaid e(penses /5)435 7:,39 73,.20
Ae$erred income ta( bene$its /1*)331 7.,32 7:,830
Total c"rrent assets /231)31* 7208,089 722,9
"ro5ert%) 5#ant and eC+i5'ent) at cost
Band and b"ildin%s /23)53* 7.0,82 7::,206
!i(t"res and e4"ipment /31)332 7:.,93 7::,2.:
Comp"ter hardware and so$tware /25)4** 7:6,82: 76.,6::
Beasehold impro)ements /3)144 73,00 72,286
Total property, plant and e4"ipment /223)232 720:,62: 726,060
Bess - acc"m"lated depreciation and amortiCation /02)222 729,82: 7.:,29:
-roperty, plant and e4"ipment, net /123)*14 720,660 70.,.26
Intan%ibles, net /1)234 7623 7:22
Total assets /310)421 7328,898 728:,92.
!ia(i#ities and shareho#derDs in4est'ent
C+rrent #ia(i#ities:
Bines o$ credit /1*)51* 7,0 7.,:2
,cco"nts payable /54)113 7:2,908 762,632
*eser)e $or ret"rns /3)1** 79,280 79,9
,ccr"ed liabilities /3*)402 72:,.32 722,660
,ccr"ed pro$it sharin% /3)1*1 7,932 7,.86
Income ta(es payable /13)222 72,922 7:,:::
Total c"rrent liabilities /12*)312 7:,2:2 782,0:.
&e9erred inco'e ta<es /1)345 78,6:8 79,82:
Shareho#dersD in4est'ent:
Common stoc#, 2:,66 shares iss"ed /231 72: 72:
Aonated capital /5)43* 79,6:0 79,6:0
,dditional paid-in capital /25)210 720,.60 78,3
Ae$erred compensation ?/33@ /7.80 /7930
,cc"m"lated other comprehensi)e income /2)123 73,223 7,.38
*etained earnin%s /331)4*2 73.,80. 7289,320
Treas"ry stoc#, :,:96, .,6, and :,96: shares at cost, respecti)ely ?/134)512@ /763,8900 /728,6:20
Total shareholdersD in)estment /23*)432 7206,222 782,939
Total liabilities and shareholdersD in)estment /310)421 7328,898 728:,92.
The McGraw-Hill Companies, Inc., 202
2*12
?+na+dited@
PBC:
Prepared by Client
ERTHWER C!OTHIERS -2
Conso#idated State'ents o9 O5erations PBC
(In thousands# exce"t "er share data) 2535202
!or the period ended Aecember 3
2*11 2*1*
Net Sa#es /1)*10)10* 7890,626 729.,229
Cost o$ sales /522)153 796:,383 76.2,.38
Gross -ro$it /442)232 7606,08 7329,6:
1ellin%, %eneral and administrati)e e(penses /324)11* 73:6,02 7336,886
?on-rec"rrin% char%e /credit0 /7,930
Inco'e 9ro' o5erations /23)552 760,.28 79,309
;ther income /e(pense0E
Interest e(pense ?/121@ /78230 /7,2280
Interest income /010 7,698 79.3
Gain on sale o$ s"bsidiary
;ther ?/3)514@ /76,.820 /7,080
Total other income /e(pense0, net ?/3)4*3@ /76,3220 /7,.6.0
Income be$ore income ta(es /2*)154 739,.9. 768,998
Income ta( pro)ision /23)351 73,230 72,33.
Net inco'e /43)405 722,92. 73,222
-asic earnin$s 5er share 1,41 .9 .:0
&i#+ted earnin$s 5er share 1,45 .6 .9:
Fasic wei%hted a)era%e shares o"tstandin% 10)150 8,93 8,999
Ail"ted wei%hted a)era%e shares o"tstandin% 10)415 8,..6 20,099
The McGraw-Hill Companies, Inc., 202
2*12
?+na+dited@
PBC:
Prepared by Client
ERTHWER C!OTHIERS -3
Conso#idated State'ents o9 Cash A#o>s PBC
(In thousands) 2535202
!or the period ended Aecember 3
Cash 9#o>s 9ro' ?+sed 9or@ o5eratin$ acti4ities:
2*11 2*1*
Net inco'e /43)405 722,92. 73,222
,d@"stments to reconcile net income to
net cash $lows $rom operatin% acti)itiesE
?on-rec"rrin% char%e /credit0 /7,930
Aepreciation and amortiCation /12)515 79,23 73,6:9
Ae$erred compensation e(pense /42 7.9 703
Ae$erred income ta(es ?/4)33*@ 73,360 79,3.:
-reta( %ain on sale o$ s"bsidiary
Boss on disposal o$ $i(ed assets /1)521 7226 7:02
Chan%es in assets and liabilities e(cl"din%
the e$$ects o$ di)estit"resE
*ecei)ables, net /4)232 /7,33:0 72,:9
In)entory ?/25)353@ /7:,820 73.,3.0
-repaid ad)ertisin% /1)243 /7:2:0 73,0
;ther prepaid e(penses ?/111@ /72,9360 7,92
,cco"nts payable ?/1)323@ 76,0.2 /72,.20
*eser)e $or ret"rns /21* 7..9 7638
,ccr"ed liabilities /5)5*2 /7.080 /76,8220
,ccr"ed pro$it sharin% /1)523 /72:20 7322
Income ta(es payable /2)334 7,823 /72,200
Ta( bene$it o$ stoc# options /4)020 7,628 7,.:9
;ther ?/1)4*4@ 72,66 763.
?et cash $rom /"sed $or0 operatin% acti)ities /42)221 738,3:. 7.8,2.
Cash 9#o>s 9ro' ?+sed 9or@ in4estin$ acti4ities:
Cash paid $or capital additions ?/23)334@ /722,8980 /72,2020
-roceeds $rom sale o$ s"bsidiary
?et cash $lows "sed $or in)estin% acti)ities ?/23)334@ /722,8980 /72,2020
Cash 9#o>s 9ro' ?+sed 9or@ 9inancin$ acti4ities:
-roceeds $rom /payment o$0 short-term debt ?/5*1@ 73,380 /7.,:820
-"rchases o$ treas"ry stoc# ?/1)*52@ /72,820 /72,8390
Iss"ance o$ treas"ry stoc# /12)40* 73,.06 76,3.
?et cash $lows "sed $or $inancin% acti)ities /1)032 /7,08.0 /7:,300
Net increase ?decrease@ in cash and cash eC+i4a#ents /3*)311 /7:800 769,392
-e$innin$ cash and cash eC+i4a#ents /41)021 768,::2 76,3.
Endin$ cash and cash eC+i4a#ents /20)350 762,8.2 768,::2
S+55#e'enta# cash 9#o> disc#os+res:
Interest paid /121 782. 7,228
Income ta(es paid /21)431 7:,2.2 73,.0
The McGraw-Hill Companies, Inc., 202
2*12
?+na+dited@
PBC:
Prepared by Client
ERTHWER C!OTHIERS -6
Conso#idated State'ents o9 Stoc.ho#dersD In4est'ent PBC
(In thousands) 2535202
,cc"m"lated
,dditional ;ther
Comprehensi)e Common Aonated -aid-in Ae$erred Comprehensi)e *etained Treas"ry
Income 1toc# Capital Capital Compensation Income &arnin%s 1toc# Total
Falance, Aecember 3, 2008 72: 79,6:0 7.,96: /729.0 7,302 72:6,92 /730,2660 79.,:2:
-"rchase o$ treas"ry stoc# /72,8390 /72,8390
Iss"ance o$ treas"ry stoc# 76,3. 76,3.
Ta( bene$it o$ stoc# options e(ercised 7,.:9 7,.:9
Ae$erred compensation e(pense 703 703
Comprehensi)e incomeE
?et income 73,222 73,222 73,222
!orei%n c"rrency translation ad@"stments 7:0 7:0 7:0
GnrealiCed %ain on $orward contracts 73.. 73.. 73..
Comprehensi)e income 73,:98
Falance, Aecember 3, 200 72: 79,6:0 78,3 /7960 7,.38 7289,320 /728,6:20 782,936
-"rchase o$ treas"ry stoc# /72,820 /72,820
Iss"ance o$ treas"ry stoc# 73,.06 73,.06
Ta( bene$it o$ stoc# options e(ercised 7,628 7,628
Ae$erred compensation e(pense 7.9 7.9
Comprehensi)e incomeE
?et income 722,92. 722,92. 722,92.
;ther comprehensi)e incomeE
!orei%n c"rrency translation ad@"stments /7,90 /7,90 /7,90
GnrealiCed %ain on $orward contracts 73,289 73,289 73,289
Comprehensi)e income 726,:.
Falance, Aecember 3, 20 72: 79,6:0 720,.60 /7.80 73,223 73.,80. /763,8900 7206,222
-"rchase o$ treas"ry stoc# /72,0920 /72,0920
Iss"ance o$ treas"ry stoc# 7.,680 7.,680
Ta( bene$it o$ stoc# options e(ercised 76,8.8 76,8.8
Ae$erred compensation e(pense 762 762
Comprehensi)e incomeE 763,689
?et income 763,689 763,689
;ther comprehensi)e incomeE
!orei%n c"rrency translation ad@"stments /7220 /7220 /7220
GnrealiCed %ain on $orward contracts /7,6280 /7,6280 /7,6280
Comprehensi)e income 76,.29
Falance, Aecember 3, 202 72: 79,6:0 729,.8 /73:0 72,.3 73:,602 /736,920 72:0,6:.
The McGraw-Hill Companies, Inc., 202
PBC:
Prepared by Client
ERTHWER C!OTHIERS -9
Ai4e-;ear Conso#idated Ainancia# S+''ar% ?+na+dited@ PBC
(In thousands# exce"t "er share data) 2535202
!or the period ended Aecember 3
2*11 2*1* 2**0 2**1
Inco'e state'ent data:
?et 1ales 1)*10)10* 890,626 29.,229 28,386 22,398
-reta( Income 2*)154 39,.9. 68,998 32,.9 ::,2:
-ercent o$ net sales 3,07 3.2< 9.2< 3.:< 2.<
?et income 43)405 22,92. 3,222 20,2.0 6,:82
"er share o9 co''on stoc.:
Fasic earnin%s per share 1,41 .9 .:0 .02 2.0
Ail"ted earnin%s per share 1,45 .6 .9: .0 2.00
Common shares o"tstandin% 10)150 8,93 8,999 8,20: 20,.03
-a#ance sheet data:
C"rrent assets 231)31* 208,089 22,9 8,28. 86,669
C"rrent liabilities 12*)312 :,2:2 82,0:. 33,636 2,302
--& and intan%ibles 122)241 20,2:6 02,62 09,09 2.,32
Total assets 310)421 328,898 28:,92. 28:,36. 22,.9.
?onc"rrent liabilities 1)345 8,6:8 9,82: 9,22: 9,:2:
1hareholdersD in)estment 23*)432 206,222 82,939 9.,:2. 9.,.:3
Other data:
?et wor#in% capital 141)*33 82,22. 80,062 9.,2:3 .:,3:
Capital e(pendit"res 23)334 22,898 2,202 30,322 3,362
Aepreciation and amortiCation e(pense 12)515 9,23 3,6:9 2,.9 8,233
*et"rn on a)era%e shareholdersD in)estment 107 < 2< 3< 22<
*et"rn on a)era%e assets 127 .< < .< :<
The McGraw-Hill Companies, Inc., 202
2*12
?+na+dited@
PBC:
Prepared by Client