| Course | ACC 640 Auditing |
|---|---|
| Module | Module 3 |
| Paper type | graduate audit planning milestone on materiality and risk assessment |
| Length | About 1,020 words, 6 pages |
| Format | APA 7 student paper |
| School | Southern New Hampshire University |
| Program | MS Accounting |
| Updated | October 2026 |
Free sample paper for ACC 640 Module 3
Audit Planning Memo: Materiality and Risk Assessment, Fiscal 2025
[Student Name]
Southern New Hampshire University
ACC 640: Auditing
Milestone One
[Instructor Name]
[Date]
The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.
Audit Planning Memo: Materiality and Risk Assessment, Fiscal 2025
Introduction
This memo documents planning decisions for the fiscal 2025 integrated audit of the company, our first year as its auditor. It sets materiality under AS 2105 (Public Company Accounting Oversight Board, 2016a) and assesses the risks of material misstatement under AS 2110. The company expects revenue of about $412 million, 60 percent online and 40 percent wholesale, and pretax income of about $18.5 million, down from $26.0 million in 2024 because of heavier discounting and higher returns.
Materiality
Pretax income is the measure the company's investors and analysts focus on, so it is the natural benchmark. But 2025 income is unusually low, and basing materiality on it alone would set a threshold well below what users would consider important for a company of this size. We therefore use pretax income averaged over 2023 through 2025, $22.2 million, and apply 5 percent, giving overall materiality of $1.1 million. A cross-check against revenue at 0.25 percent gives $1.03 million, which supports the figure. Eilifsen and Messier (2015) found that the major firms' guidance most often uses 5 percent of pretax income, with normalized income permitted when results are volatile, which matches this choice.
Materiality thresholds
| Measure | Basis | Amount |
|---|---|---|
| Overall materiality | 5 percent of three-year average pretax income | $1,100,000 |
| Performance materiality | 60 percent of overall | $660,000 |
| Posting threshold for misstatements | 5 percent of overall | $55,000 |
Performance materiality is set at 60 percent, at the low end of the firm's range, because this is a first-year audit, a material weakness was reported by the predecessor and the finance team has turned over. Misstatements below $55,000 are considered clearly trivial and are not accumulated.
Preliminary Analytical Procedures
Comparing 2025 interim results with 2024 and industry data revealed three patterns. Online returns rose from 11 percent to 14 percent of online sales, while the reserve as a percentage of fourth-quarter online sales was unchanged. Inventory grew 22 percent while sales grew 4 percent, and the share of inventory older than one season rose. And fourth-quarter online sales have historically been concentrated in the last ten days of December, when shipping cutoffs are tight. Each pattern points to a risk.
Significant Risks
AS 2110 requires the auditor to identify significant risks, those needing special audit consideration, and to presume a fraud risk in revenue recognition (Public Company Accounting Oversight Board, 2016b).
Significant risks and planned responses
| Account | Assertion | Risk | Planned response |
|---|---|---|---|
| Online revenue | Occurrence, cutoff | Orders shipped in January recorded in December; IT weakness lets developers alter order data | Full-population analytics matching orders to carrier shipment records for the last 15 days of December and first 15 of January |
| Returns reserve | Valuation | Reserve not updated for higher return rates and the new lifetime returns policy | Independent expectation from return data by product line; test data used in management's model |
| Inventory at third-party warehouses | Existence, valuation | Counts not observed by us; aged styles carried above net realizable value | Observe counts at both warehouses; obtain service auditor's reports; test markdowns after year end |
| Journal entries | All | Management override, heightened by turnover and pressure on earnings | Data analytics over all manual entries, focused on late, round-dollar and unusual-account entries |
The revenue risk is focused on online cutoff rather than wholesale, because wholesale shipments are fewer, larger and easier to confirm. The returns reserve is significant because it is an estimate with high subjectivity, and the predecessor raised its methodology. Inventory is significant because of both existence, with goods held by third parties, and valuation, with the buildup of aged stock.
Fraud Risk Discussion
The engagement team met on October 6 to discuss how the financial statements could be materially misstated through fraud, as AS 2401 requires. Incentive and pressure are present: earnings fell 29 percent, the share price dropped and executive bonuses depend on operating income. Opportunity exists through the IT weakness, which allowed developers to change order data, and through the turnover in finance. The team identified three scenarios worth specific responses: holding the online sales system open past midnight on December 31, understating the returns reserve to protect fourth-quarter margins and delaying markdowns on aged inventory. Each is covered by a response in the risk table. The team also agreed to vary the timing and location of procedures, including an unannounced visit to the smaller warehouse.
Using the Work of Others
Both warehouses are operated by third-party logistics providers who issue SOC 1 Type 2 reports on their inventory controls. We will obtain both reports, check that they cover most of our audit period, evaluate the service auditors' qualifications and test the complementary user entity controls the reports assume the company performs, such as monthly reconciliation of warehouse records to the general ledger. The company's two-person internal audit function reports to the audit committee and tests store and warehouse controls; we will consider using its work on low-risk areas but not on significant risks.
Other Risks and Controls
Wholesale receivables, accounts payable, leases for the headquarters and a distribution office, and equity compensation are assessed as having normal risk and will be audited with standard procedures. Because of the IT general controls weakness, we will not rely on automated controls over online revenue unless remediation is completed and tested before year end; until then, our response to the revenue risk is substantive. For the integrated audit, we will test management's remediation of developer access in the fourth quarter (Arens et al., 2020).
Opening Balances
As a first-year auditor, we must obtain evidence that opening balances do not contain material misstatements. We will review the predecessor's working papers for inventory and the returns reserve at December 31, 2024, and perform rollback procedures from our year-end count. If the opening reserve was understated, part of the 2025 returns expense may belong to 2024, which would affect the comparability of the two years.
Conclusion
Materiality of $1.1 million and performance materiality of $660,000 reflect a company whose earnings fell and whose controls are weaker than last year. The audit will spend its effort where the analytics point: online cutoff, returns, inventory and journal entries. Milestone Two will develop the audit program for inventory at the third-party warehouses.
References
Arens, A. A., Elder, R. J., Beasley, M. S., & Hogan, C. E. (2020). Auditing and assurance services (17th ed.). Pearson.
Eilifsen, A., & Messier, W. F. (2015). Materiality guidance of the major public accounting firms. Auditing: A Journal of Practice & Theory, 34(2), 3-26. https://doi.org/10.2308/ajpt-50882
Public Company Accounting Oversight Board. (2016a). Consideration of materiality in planning and performing an audit (AS 2105). Author.
Public Company Accounting Oversight Board. (2016b). Identifying and assessing risks of material misstatement (AS 2110). Author.
What the ACC 640 Module 3 instructions ask for
The first ACC 640 milestone usually asks you to plan the audit of a case company: determine materiality, assess the risks of material misstatement and outline how the audit will respond. Plan to select a materiality benchmark and percentage with a reason, set performance materiality and a threshold for posting misstatements, perform preliminary analytical procedures, identify significant accounts and relevant assertions, and decide which risks are significant. Cite AS 2105 for materiality and AS 2110 for risk assessment, and explain each judgment, since the grader is evaluating your reasoning more than the arithmetic. A risk table linking accounts, assertions, risks and responses is the usual centerpiece, supported by a short narrative on each significant risk.
How this ACC 640 Module 3 milestone one example is built
The milestone sets overall materiality at $1.1 million, 5 percent of pretax income averaged over three years, because 2025 income fell sharply and a single-year benchmark would understate the company's scale; a revenue cross-check at 0.25 percent gives a similar figure. Performance materiality is 60 percent, $660,000, lower than usual because of the first-year audit and the IT material weakness. Preliminary analytics show returns rising and inventory growing faster than sales. Four significant risks follow: cutoff of online sales at year end, the returns reserve, existence and valuation of inventory at third-party warehouses and management override through journal entries, each with a planned response. The memo also covers fraud brainstorming, reliance on the warehouses' service auditors and opening balances.
Where the ACC 640 Module 3 rubric puts the points
Rubrics for the first ACC 640 milestone typically score the materiality determination and its justification, performance materiality and posting threshold, preliminary analytics, identification of significant accounts and assertions, significant risk assessment, linkage to planned responses and citation of standards. Top papers explain why a benchmark fits this client, adjust performance materiality for specific risk factors, use analytics to find risks and connect each risk to an assertion and a procedure. Graders also reward recognizing the presumed fraud risk in revenue and the special steps a first-year audit requires for opening balances. Common deductions include unexplained percentages, generic risk lists, risks not tied to assertions and responses that do not address the stated risk.
ACC 640 Module 3 help: the mistakes that cost points
Planning milestones most often slip by listing risks that could apply to any company, such as revenue or inventory, without saying what could go wrong at this client and in which assertion. A second weak spot is materiality that is computed but not defended, especially when income is volatile. If your case is a private company audit, AICPA standards apply, but the same benchmark reasoning and risk linkage work. Build the risk table before writing the narrative; when each row shows an account, an assertion, a specific risk and a procedure that would detect it, the memo almost writes itself. Then defend the materiality figure in two or three sentences.
Get ACC 640 Module 3 written to your instructions
Send the ACC 640 Milestone One guidelines along with the client's numbers. The milestone will choose and justify a materiality benchmark, set the related thresholds, assess risks by account and assertion and outline responses tied to the standards. Plan on roughly two days; your first costs nothing. The paper above is an original model document written by our desk, not a submitted student paper and not an official Southern New Hampshire University document.
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ACC 640 Module 3 questions, answered
Where can I find a free ACC 640 Module 3 Milestone One sample?
This page includes a full ACC 640 Milestone One setting materiality and assessing significant risks for a first-year audit.
How do auditors choose a materiality benchmark?
By selecting a measure users focus on and that is stable, often pretax income, with revenue, assets or normalized income used when income is volatile or near zero.
What is performance materiality?
A lower working threshold, commonly between half and three quarters of overall materiality, set to reduce to an appropriately low level the chance that uncorrected and undetected misstatements together exceed materiality.
What is a significant risk?
A risk of material misstatement that requires special audit consideration, such as fraud risks, significant unusual transactions and complex estimates.
Is revenue always a fraud risk?
AS 2110 requires the auditor to presume a fraud risk involving improper revenue recognition and to evaluate which types of revenue or transactions give rise to it.