03
Feb
10

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


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