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Cloud 9 Ltd.
December 31, 2014
Users Financial statement area of most concern to the user
Cloud 9 Inc. This is the parent company of Cloud 9 Ltd. They are
concerned with the company’s ability grow its market
share of the North American footwear market. This would
best be reflected by revenues.
Bank Concerned with the ability of Cloud 9 to repay borrowed
funds. As a result, it is mostly concerned with net income
as this is the best predictor of an entity’s future ability to
Management Concerned primarily with revenues as this is the basis for
Base selected for planning materiality (PM): _________________________________
Justification for selection:
Revenue is the most appropriate basis for calculating PM. This is the preferred method
• Cloud 9 is currently in a loss for the year ended December 31, 2014; therefore, net
income before tax is not an appropriate basis.
• The parent entity (main users of the accounts) is concerned with increasing the
market share of the Canadian market—essentially revenue.
• Management has an incentive to manipulate revenue based on growth targets
expected and compensation attached to meeting those targets.
Calculation of PM
Current Year Prior Year
Trial balance amount: $ 37,194,932 $ 34,038,192
(that is, non-recurring items)
$ 0 $ 0
Annualized (if required): NA; full-year balances used NA; full-year balances used
Benchmark applied 0.5% of revenues
Calculated materiality: $ 37,194,192 × 0.5% =
Conclusion: PM materiality is $185,000 (rounded).
Performance materiality: 60% × $185,000 = $111,000.
Conclusion: Performance materiality is $111,000 .
Consider how you will use the planning materiality in your audit. What factors might lead
you to increase or decrease the planning materiality amount?
NOTE TO THE LECTURER:
Additional discussion points
How would the planning materiality be used?
• To compare fluctuations in (annualized) accounts between years, those with
fluctuations greater than materiality may need greater attention.
• In the allocation of resources within the audit, those accounts with greater levels of
inherent risk and more material accounts may receive more audit hours.
What would lead the auditor to increase or decrease materiality?
• There could be uncertainty in the external environment. For example, during the
global financial crisis, auditors may have been more conservative and decreased
the level of materiality to ensure detection of material misstatements.
• If this is a new audit client, the auditor may set materiality lower in the first year
while gathering an understanding of the client. If no material misstatements are
found in the first year, it may be increased on subsequent audits.