The auditors of Letron Inc. have set an overall materiality level of $900,000 and a performance materiality level of $800,000 for the current year audit, 20X2. They used the same materiality levels in their 20X1 audit. Letron is in the telecommunication equipment business and its inventory value is subject to fluctuations due to changes in supply and demand as well as technological obsolescence, creating considerable measurement uncertainty.
Management’s point estimate of the inventories’ value as of the end of 20X2 is $15.9m, after reversal of a write-down that was taken in 20X1. The auditors have established a range of estimates for the inventory value of $14–16 million, so management’s point estimate is within the auditors’ range. In 20X1, poor market conditions prevailed and Letron wrote down its inventory to net realizable value, estimated to be $12.3. Management and the auditor had a disagreement regarding inventory valuation for 20X1, because it fell outside of the auditors’ range of $13–15 million. However, this difference and the aggregated misstatements for 20X1 were less than the performance materiality, so these misstatements were not corrected. Letron initiated a bonus plan in 20X0 that would reward top management if the company reported positive profits. Letron reported losses in 20X0 and 20X1. In 20X2, Letron reported a small profit, giving rise to a substantial bonus to its management team.
Assume the role of Letron’s auditor, and explain the actions you would take in this situation, based on applying the requirements and guidance in CAS 450 and CAS 540.