A.01 Internet Problem (Worksheet 9)

Shelly Huzaynah 21207019

SMAK01-7

Auditing 2

Question :

Internet Problem 9-1 (Materiality and Tolerable Misstatement)

Establishing materiality for the audit of a client’s financial statement requires considerable judgment. The allocation of the auditor’s preliminary judgment about materiality to the client’s accounts requires substantial judgment as well. For this reason, decisions about materiality are made by more experienced auditors. The following problem affords you an opportunity to apply the concept of materiality to an actual set of financial statements.

1. Imagine that you are employed as an auditor in a CPA firm that performs the audit of Microsoft. Your firm’s materiality guidelines indicate that overall engagement materiality should be set at an amount between five and ten percent of income before taxes.
   1. Apply your firm’s guidelines to Microsoft’s 2003 financial statements. What percentage of income before taxes do you believe is appropriate? Why? What do you.
   2. Given Microsoft’s 2003 balance sheet, what asset line items would be allocated the highest amount of tolerable misstatement? Why?

Answer :

2.  Precentage of income before taxes between 5% – 10%. It’s appropriate, and not exceed misstatement maeriality level.

The steps in applying materiality:

• Determine initial consideration of materiality.

• Allocate initial consideration of materiality to the segment.

• Estimated total errors in the segment.

• Estimate the combined error.

• Compare estimates combined with the initial consideration of materiality.

Income Statement

(In millions, except earnings per share)
Year Ended June 30	2001	2002		2003
Revenue	$ 25,296	$ 28,365		$ 32,187
Operating expenses:
Cost of revenue	3,455	5,191		5,686
Research and development	4,379	4,307		4,659
Sales and marketing	4,885	5,407		6,521
General and administrative	857	1,550		2,104
Total operating expenses	13,576	16,455		18,970
Operating income	11,720	11,910		13,217
Losses on equity investees and other	(159)	(92)		(68)
Investment income/(loss)	(36)	(305)		1,577
Income before income taxes	11,525	11,513		14,726
Provision for income taxes	3,804	3,684		4,733
Income before accounting change	7,721	7,829		9,993
Cumulative effect of accounting change (net of income taxes of $185)	(375)	-		-
Net income	$ 7,346	$  7,829		$  9,993
Basic earnings per share(1):
Before accounting change	$    0.72	$    0.72		$    0.93
Cumulative effect of accounting change	(0.03)	-		-
	$    0.69	$    0.72		$    0.93
Diluted earnings per share(1):
Before accounting change	$    0.69	$    0.70		$    0.92
Cumulative effect of accounting change	(0.03)	-		-
	$    0.66	$    0.70		$    0.92
Weighted average shares outstanding(1):
Basic	10,683	10,811		10,723
Diluted	11,148	11,106		10,882

(2)    Earnings per share and weighted average shares outstanding have been restated to reflect a two-for-one stock split in February 2003.

1. The asset line items would be allocated the highest amount of tolerable misstatement in the balance sheet of Microsoft’s is Account Receivable, because in this balance sheet report account receivable provides the highes amount in the assets, and the company’s account receivable increase every year.

Balance Sheet

(In millions)
June 30	2002		2003
Assets
Current assets:
Cash and equivalents	$   3,016		$   6,438
Short-term investments	35,636		42,610
Total cash and short-term investments	38,652		49,048
Accounts receivable, net	5,129		5,196
Inventories	673		640
Deferred income taxes	2,112		2,506
Other	2,010		1,583
Total current assets	48,576		58,973
Property and equipment, net	2,268		2,223
Equity and other investments	14,191		13,692
Goodwill	1,426		3,128
Intangible assets, net	243		384
Other long-term assets	942		1,171
Total assets	$ 67,646		$ 79,571
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$   1,208		$   1,573
Accrued compensation	1,145		1,416
Income taxes	2,022		2,044
Short-term unearned revenue	5,920		7,225
Other	2,449		1,716
Total current liabilities	12,744		13,974
Long-term unearned revenue	1,823		1,790
Deferred income taxes	398		1,731
Other long-term liabilities	501		1,056
Commitments and contingencies
Stockholders’ equity:
Common stock and paid-in capital – shares authorized 24,000; Shares issued and outstanding 10,718 and 10,771	31,647		35,344
Retained earnings, including accumulated other comprehensive income of $ 583 and $ 1,840	20,533		25,676
Total stockholders’ equity	52,180		61,020
Total liabilities and stockholders’ equity	$ 67,646		$ 79,571

Source :

http://www.microsoft.com/msft/reports/ar03/alt/income.htm

http://www.microsoft.com/msft/reports/ar03/alt/balance.htm