As what has been provided in PSA 315, the objective of the auditor is to assess the

risk of material misstatements, whether due to fraud or error, by understanding the

entity in order to design procedures in response to the assessed risks. In
understanding the entity, its selection and application of accounting policies
including the reasons for changes thereto must be considered. This may encompass
matters such as the methods the entity uses to account for significant and

unusual transactions and changes in its accounting policies. In the case,

The fraudulent write-off of a customers account is another way to bring the account up-to-date without the
organization receiving the payment. As noted earlier, the customer is going to complain after receiving a
second bill for the amount he or she has already paid. This can provoke internal investigation of the missing
funds. To prevent customers complaints, the perpetrator of the crime has to keep the second bill from being
sent to the customer. The customer will not be billed by the organization if the account is written off. The
perpetrator would therefore try to write-off the customer account and steal the funds that the customer sent as
payment. This way the funds are stolen, the customer isnt billed repeatedly, and the accounting records
balance. Because most large organizations segregate the duties of receiving cash, maintaining accounts
receivables records, and authorizing write-offs, collusion between employees has to occur for this scheme to
be successful.

Overstated Receivable

Accounts receivable is an asset account, and companies report the

value of accounts receivable differently under the indirect allowance method
and the direct write-off method. With the account of allowance for doubtful
accounts, companies report the carrying value of accounts receivable net of
the amount of allowance, reflecting the true, realizable value of the accounts
receivable. Using the direct write-off method, companies overstate the value
of accounts receivable when certain accounts receivable have become
uncollectible but have not been written off.

Manipulated Earnings

Unlike the allowance method that records the estimated uncollectible

accounts receivable at the time of the sales, the direct write-off method
allows companies to select the period in which they would like to write off
any uncollectible accounts receivable, potentially causing earnings
manipulation. If earnings are down, companies may delay any write-off of
uncollectible accounts receivable to avoid further decrease in reported
earnings. Because of such a drawback in using the direct write-off method,
the method often is not used except when the amount uncollectible is
immaterial.

As stated by PSA 320, In planning the audit, the auditor makes judgments
about the size of misstatements that will be considered material in order to
determine the nature, timing and extent of audit procedures. Thus an auditor
makes a preliminary assessment of materiality of the financial statements as a
whole by determining the amount by which they believe the financial
statements would be misstated without affecting users decision. This is called
the preliminary judgment about materiality or planning materiality. The planning
materiality is determined by exercising professional judgment, and as such, it is
not necessary to quantify the same. But often, it is and benchmarks are often
used in coming up with a materiality level. PSA 320 provided factors for
determining the appropriate benchmark for an audit engagement, and this
includes the nature of the entity. How do we use these benchmarks? We multiply
it with a certain percentage. In practice, as stated by Cabrera, 3-7% of the
companys profit before tax is commonly used. In the PSA 320, an example was
provided wherein, for a manufacturing for profit entity, an auditor may consider
5% of its profit before taxes in determining the amount of materiality. Applying
that to the Lone Star engagement, since it is a manufacturing company that is
profit-oriented, we will get a preliminary judgment about materiality of 45,450.
(909,000 multiplied by 5%)