(a) How close does the Bees’ reported ticket revenue for 2018 have to be to your expectation for you to consider reported ticket revenue reasonable or fairly stated (i.e., provide a high level of assurance)? (b) If reported ticket revenues were outside your “reasonable range,” what could explain the difference? (c) Would you consider it acceptable for auditors to design substantive

Question

analytical procedures to obtain moderate or low assurance by accepting a difference between reported and expected revenue that is 2 or 3 times the size of audit materiality?

What will be an ideal response?

Answer 1

a) For substantive analytical procedures, if the auditor desires a high level of assurance, the tolerable
difference can be no greater than overall materiality. The case provides pre-tax net income. If we
apply the typical rule of thumb of 5% of pre-tax net income to compute materiality, we obtain
$46,885. The size of materiality raises a number of important points that should be discussed:
Materiality as a percentage of total revenue is less than 1%. This is common for accounts on
both the income statement and balance sheet and it highlights why it is impractical in most
cases to audit aggregate account balances and obtain a high level of assurance (see 4c below.
Rather, auditors will typically need to examine revenue components (i.e., by product, location,
subsidiary, division) separately.
The disaggregated expectation yielded a difference of $19,643. To the extent the inputs
to the auditor’s expectation are reliable (i.e., audited, from third parties) the analytical
procedure appears to provide strong evidence that revenue is fairly stated. Students may
ask if it is common for auditors in practice to be able to derive such precise and effective
revenue analytical procedures. The answer is that yes it is rather common for certain revenue
components. For example interest revenue for financial institutions, room revenue for hotels,
natural gas revenue for residential customers (as a function of weather or “heating degree
days”), and cable TV revenue.
The aggregated procedures yield differences that are greater than materiality. Differences
larger than materiality are investigated and frequently lead the auditor to develop more precise
expectations. However, as noted in the suggested solution to question 1, even if the aggregated
procedures yielded differences less than materiality, the auditor should take little comfort in
the evidence because the expectations are of low quality.
b) If the reported ticket revenue is outside the reasonable range it could be explained by a number
of reasons such as:
Revenues are misstated.
The auditor’s expectation failed to incorporate important factors. In the Bees case it could
be information about season ticket packages, group packages, games played in poor weather,
changing sales mix, mid-season price changes, free ticket give-a-ways, etc.
Auditor error. There may be a mathematical error or the model used to develop the expectation
may be incorrectly specified.
The total attendance figure is wrong.
c) Yes, it is acceptable and could be advisable to use a threshold that is a multiple of materiality if the
auditor does not need to obtain a high level of assurance from a substantive analytical procedure.
U.S. and international audit firms have designed audit metholodologies around such practices,
which are acceptable from an auditing standard perspective and supported by this acadmic article,
"Between a Rock and a Hard Place: A Path Forward for Using Substantive Analytical Procedures in
Auditing Large P&L Accounts: Commentary and Analysis" by S. Glover, D. Prawitt and M. Drake
appearing in Auditing: A Journal of Practice and Theory, 2015, pp. 161-179. The authors review the
challenges in designing substantive analytical procedures to obtain a high level of assurance when
materiality as a percentage of accounts like revenue is typically less than 1%. As noted in the
article, it would be rare that auditors would ever need a high level of assurance from a substantive
analytical procedure addressing revenue because there will be audit evidence from revenue related
controls testing and other audit procedures (e.g., cut-off testing, accounts receivable testing,
journal entry testing). The authors provide an approach to obtain moderate or low assurance and
help explain how the approach is consistent with current U.S. and international auditing standards.
We recommend instructors consider assigning the article as a reading assignment, particularly for
advanced auditing courses.