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Hi sir, I’ve watched the lectures but I don’t seem to understand how to determine whether a matter is material only or material and pervasive . Can you explain to me ?
For example for the following scenarios below how do we know if the matter is material only or material and pervasive ?
Scenario 1: Depreciation had not been provided on any non-current asset for a number of years, the effect of which if corrected would be to turn an accumulated profit into a significant accumulated loss.
Scenario 2: Aragon Company made a very poor attempt to conduct their inventory count. You attended, however there was insufficient evidence that the inventory valuation at $4 million is accurate. Sales revenue was $50 million and profit for the year was $15 million.
Whether or not a misstatement is material or material and pervasive is a matter of judgement for the audit partner and there is not easy or definitely correct way of deciding. The dictionary definition of ‘pervasive’ is: “present or noticeable in every part of a thing or place” (Cambridge Dictionaries), so the misstatement (or missing evidence) has to be so great that the financial statements are so undermined that they are effectively useless. The problem cannot be ring-fenced and limited to a particular figure.
Scenario 1: I can’t even tell if this is material. It might be a company in the service industry which has very low non-current assets. I don’t know how large the profits/losses are and the word ‘significant’ is a bit hazy.
Scenario 2: Material levels with respect to revenue are 0.25 – 0.5m and with respect to profits are 0.75 to 1.5m, so $4m is certainly material. However, even if inventory were 0, the profit would only be reduced to 11m – still healthy. I would think that this owuld be regarded as material, but not pervasive. Some good information is still available from the FS.
Auditors are fairly reluctant to say that a problem is pervasive. They would rather go for the ‘except for’ qualification if they can as that is more useful to shareholders.
You will not lose many marks by not going for pervasive provided you show an understanding of the decision that has to be made. Two partners could validly come to different decisions.
Hi sir, sorry for asking on an old post. For scenario 2, how did you decide on the material levels with respect to revenue and profit? How did you get the numbers 0.25 – 0.5m and 0.75 – 1.5m respectively?
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