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The question concerns a Manufacturing entity which has a large loan from a bank with a covenant for Net Interest Coverage and Current Ratio maintenance.
While calculating the materiality , the Suggested answer takes the simple average of all possible benchmarks (Net Assets, Total Assets, PBT, Revenue) and then also considers the Qualitative factors. But it does not consider the volatility of the benchmarks – especially since the PBT of the entity changes by roughly 67% while revenue by 14%
My question is as it is a Manufacturing entity would it not be better to consider the Revenue or PBT (factoring volatility) and consider the loan covenant compliance impact as a separately material (qualitatively material) factor?
I see this is not in the Kit, nor is it a past exam Q, but a very old practice question (more than 10 years old). Setting out all the benchmarks like this has been positively discouraged for many years and never have I seen taking an average as an appropriate approach. I recommend you disregard entirely.
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