Claytonhill Beverages Ltd. is 100 percent owned by Buzz Bottling. While the company has in the past been profitable, it incurred a loss for the year ended December 31, 2012. The parent company, Buzz Bottling, has indicated that if Claytonhill incurs another loss, it will put the subsidiary up for sale. In response, Claytonhill is looking to expand its market share and therefore its profitability by performing private labeling for a nationwide supermarket chain; Value Foods Inc. Private labeling involves producing and packaging pop and other non-alcoholic beverages under the Value Foods label. However, in order to proceed with this endeavor, Claytonhill needs a packaging facility dedicated exclusively to co-packing. To finance this expansion, the company has applied to the Better Business Bank for financing.
The bank has indicated that before it will approve the loan application it would like to see audited financial statements for 2012. It also wants to ensure the entity has a current ratio of 2:1.
Claytonhill Beverages has provided you, their new auditor, with the following draft (unaudited) financial statements:
Revenue
Sales ........................................................................... 2,057,505
Cost of goods sold ........................................................... 1,445,450
Gross margin ................................................................. 612,055
Less:
General and administration costs (including bonuses of $100,000) ...... 775,899
Net income before tax ............................................................ (163,844)
Balance Sheet as at December 31, 2012
Assets
Current assets
Total cash ................................................................. 179,825
Accounts receivable, net ................................................ 64,475
Prepaid expenses ......................................................... 3,004
Inventory .................................................................. 1,507,413
Total current assets...................................................... 1,754,717
Capital assets
Office furniture & equipment, net ....................................... 85,106
Building, net ................................................................. 964,224
Land ........................................................................ 2,004,933
Total capital assets 3,054,263
Total assets ................................................................. 4,808,980
Liabilities
Current liabilities
Accounts payable ................................................................ 799,255
Other accrued expenses ......................................................... 44,875
Warranty provision .............................................................. 9,456
Current portion long-term debt ................................................ 25,000
Total current liabilities ......................................................... 878,586
Long-term liabilities
Bank loans ............................................................................. 2,200,000
Total long-term liabilities ............................................................ 2,200,000
Total liabilities ........................................................................... 3,078,586
Equity
Common shares .......................................................................... 248,000
Retained earnings ....................................................................... 1,482,394
Total equity ................................................................................. 1,730,394
Liabilities and Equity ............................................................... 4,808,980
Required
(a) Identify the users of the financial statements and their needs.
(b) Given the users' needs, what is the most appropriate base for materiality?
(c) Calculate the three levels of materiality and conclude on each.
(d) What impact did audit risk have on the materiality calculation?