Chapter 3 Cloud 9. Using Excel to Perform Materiality Planning
PROBLEM
W&S Partners has just won the January 31, 2026, audit for Cloud 9. As a part of the risk assessment phase for the new audit, the audit team needs to gain an understanding of Cloud 9s structure and its business environment, determine materiality, and assess the risk of material misstatement. This will assist the team in developing an audit strategy and designing the nature, extent, and timing of audit procedures. The trial balance at October 31, 2025 is provided here.
							Cloud 9 Trial Balance as of October 31, 2025
									Debit	Credit
							Cash and cash equivalents		$ 13,446,154
	Accounts receivable		70,485,625
	Allowance for doubtful accounts			$ 704,856
	Inventory		55,100,000
	Investments (derivatives)		13,419,231
	Deferred income taxes (current)		2,857,692
	Prepaid expenses and other current assets		9,265,385
	Property, plant, and equipment		103,803,846
	Accumulated depreciation			39,761,538
	Identifiable intangible assets and goodwill		3,723,007
	Accumulated amortization
	Deferred income taxes and other assets (noncurrent)		9,557,692
	Current portion of long-term debt			2,115,385
	Notes payable			21,376,923
	Accounts payable			14,986,457
	Accrued liabilities			25,803,846
	Income taxes payable			2,211,539
	Long-term debt			23,661,538
	Deferred income taxes and other liabilities (noncurrent)			4,915,384
	Common stock at par value			111,538
	Capital stock in excess of par value			19,415,385
	Unearned stock compensation		253,846
	Accumulated other comprehensive income		5,011,538
	Beginning retained earnings			122,857,692
	Dividends		3,866,838
	Repurchases of common stock		4,627,381
	Revenue			277,338,461
	Cost of sales		169,346,154
	Selling and administrative		79,092,308
	Interest expenses		1,438,461
	Other expense		453,846
	Income tax expense		9,511,538
	Totals		$ 555,260,542	$ 555,260,542
One task during the planning phase is to consider the concept of materiality as it applies to the client. Auditors will design procedures to identify and correct errors or irregularities that would have a material effect on the financial statements and affect the decision-making of the users of the financial statements. Materiality is used in determining audit procedures and sample selections, and evaluating differences from client records to audit results. Materiality is the maximum amount of misstatement, individually or in aggregate, that can be accepted in the financial statements. In selecting the benchmark to be used to calculate materiality, the auditors should consider the key drivers of the business. They should ask, What are the end users (that is, stockholders, banks, etc.) of the accounts going to be looking at? For example, will stockholders be interested in profit figures that can be used to pay dividends and increase share price?
						W&S Partners audit methodology dictates that one planning materiality (PM) amount is to be used for the financial statements as a whole. The benchmark selected for determining materiality is the one determined to be the key driver of the business.
												W&S Partners uses the following percentages as starting points for the various benchmarks:
																				Benchmark	Threshold (%)
								Income before tax	5.0%
								Total revenue	0.5%
								Gross profit	2.0%
								Total assets	0.5%
								Equity	1.0%
These starting points can be increased or decreased by taking into account qualitative client factors, which could be:
	The nature of the clients business and industry (for example, rapidly changing, either through growth or downsizing, or an unstable environment).
	Whether the client is a public company (or a subsidiary of a public company) subject to regulations.
	The knowledge of or high risk of fraud.
Typically, income before tax is used; however, it cannot be used if reporting a loss for the year or if profitability is not consistent. When calculating PM based on interim figures, it may be necessary to annualize the results. This allows the auditors to plan the audit properly based on an approximate projected year-end balance. Then, at year-end, the figure is adjusted, if necessary, to reflect the actual results.