End-of- chapter questions

QUESTION 1: MISSTATEMENTS IN ESTIMATES

The auditors of Letron Inc. have set an overall materiality level of $900,000 and a performance materiality level of $800,000 for the current year audit, 20x2. They used the same materiality levels in their 20x1 audit. Letron is in the telecommunication equipment business and its inventory value is subject to fluctuations due to changes in supply and demand as well as technological obsolescence, creating considerable measurement uncertainty. Management’s point estimate of the inventories’ value as of the end of 20x2 is $ 15.9m, after reversal of a writedown that was taken in 20x1. The auditors have established a range of estimates for the inventory value of SI 4—16m, so management’s point estimate is within the auditors’ range. In 20x1, poor market conditions prevailed and Letron wrote down its inventory to net realizable value estimated to be SI2.3. Management and the auditor had a disagreement regarding inventory valuation for 20x1, because it fell outside of the auditors’ range of $13—15m. However, this difference and the aggregated misstatements for 20x1 were less than the performance materiality, so these misstatements were not corrected. Letron initiated a bonus plan in 20x0 that would reward top management if the company reported positive profits. Letron reported losses in 20x0 and 20x1. In 20x2 Letron reported a small profit, giving rise to a substantial bonus to its management team.

Assume the role of Letron’s auditor, and explain the actions you would take in this situation, based on applying the requirements and guidance in ISA 450 and ISA 540. Is this compliance or fair presentation reporting? How can you tell?

QUESTION 2

Now assume in Question 1 that a uniform distribution is a good model of the uncertainty associated with the ranges, and that acceptable AccR for each estimate is .5.

Do the above estimates result in fair presentation? Is the reported small profit fairly presented? Discuss. Is the profit in compliance with standards? What is the audit risk in this situation? If the above captures all the accounting risk in this situation, what is the accounting risk associated with: beginning inventory? Ending inventory? Cost of goods sold?

QUESTION 3

In August 2019 there were allegations of accounting fraud at General Electric Corp, by Harry Markopolos that received a lot of attention in the business press. Mr. Markopolos notified the SEC of the Bernie Madoff fraud 10 years before Madoff’s Ponzi Scheme collapsed. Is he right this time as well? Find Markopolos’s 120-page analysis of the GE Corp, financial statement data and answer the following two questions:

• 1. Are GE's financial statements in compliance with GAAP?
• 2. Are GE's financial statements fairly presented?