Problem: Pat Holden is auditing the financial statements of Connell Company. The following is a summary of the uncorrected misstatements that Holden has identified during the last three years.
Year Effect on N/I Effect on asset Effect on liability Effect on equity
2011 --- (82,500) --- (100,000) --- (17,500) --- (82,500)
2012 --- (22,000) --- (25,500) --- (3,500) --- (2,200)
2013 --- 30,000 --- 30,000 --- 0 --- 30,000
These misstatements are immaterial and have related to isolated matters. In this summary, parentheses imply that the misstatements would have reduced balances if they had been corrected (for example, in 2011, the misstatements would have reduced net income by $ 82,500, assets by $ 100,000, and liabilities by $ 17,500, and equity by $ 82,500 if corrected). During the most recent audit, Holden concluded that expenses totaling $ 130,000 were recognized in January 2015 (when Connell paid them) but should have been recognized in 2014.
Required to do:
Q1. How does the misstatement identified in 2014 affect net income, assets, liabilities, and equity? (Assume a 35 percent tax rate for Connell.)
Q2. Describe the rollover method of evaluating uncorrected misstatements. Assume that performance materiality was set at $ 170,000. How would Holden evaluate the materiality of the misstatement under the rollover method? What adjustments (if any) would Holden propose to Connell's financial statements?
Q3. Describe the iron curtain method of evaluating uncorrected misstatements. Assume that performance materiality was set at $ 170,000. How would Holden evaluate the materiality of the $ 130,000 misstatement in 2014 under the iron curtain method? What adjustments (if any) would Holden propose to Connell's financial statements?
Q4. If performance materiality were established at $ 100,000 for Connell, how would Holden evaluate the materiality of the misstatement in 2014 under the rollover method and iron curtain method?
Q5. Based on your response to (d), what adjustments (if any) would Holden propose to Connell's financial statements under the rollover method and the iron curtain method?