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Materiality and Liabilities Testing - Gabriela Aguiar LLC Audit Case

Audit and evaluate documents, such as debt confirmations, vendor invoices, etc., in the audit of all of Gabriela Aguiar LLC's liability accounts. To expedite the audit process, your audit teammate has already picked up the PBC schedules and scanned and labeled them in the binder for you.

Case Background
FGCU-Accounting CPA firm has been engaged to audit Gabriela Aguiar LLC, a company based in the Fort Myers area. The audit team is led by partner Isabella Dewitt, with Ben Goldman as the audit manager. You are a senior auditor assigned to the liabilities testing portion of the audit.

Company Information:
Gabriela Aguiar LLC CEO: Gabriela Aguiar

Board of Directors: Kevin Arce, Elie Bassil, John Blasi, Connor Cizek, Stephanie Clemente, Colby Collins, Chestina Conduah

Company Background
Gabriela Aguiar LLC is a publicly traded company based in Fort Myers, Florida, specializing in luxury yacht manufacturing and leasing. Founded in 2010 by Gabriela Aguiar, the Company has grown rapidly to become a significant player in the high-end marine industry.

Key Business Details:

Primary Business: Manufacturing and leasing luxury yachts
Secondary Revenue Streams: Yacht maintenance services and marine equipment sales
Market Position: Mid-sized Company with a strong presence in the southeastern S
Recent Development: Expanding operations to the Caribbean market
Public Trading: Listed on NASDAQ under the ticker symbol GAYL
Company History and Current Situation
Gabriela Aguiar, a former naval architect, founded the Company with a vision to create customizable, eco-friendly luxury yachts. The Company's innovative designs and commitment to sustainability quickly gained attention in the industry. In 2018, Gabriela Aguiar LLC went public to fund its expansion plans. The Company has since opened a new manufacturing facility in Fort Myers and established a leasing office in Miami.

Recent challenges include:
Supply chain disruptions affecting the timely delivery of specialized materials
Increased competition in the luxury yacht market
Regulatory changes related to environmental standards in yacht manufacturing Financial Snapshot:
Annual Revenue: Approximately $150 million
Total Assets: Around $300 million
Significant Liabilities: Long-term debt for manufacturing facilities, accounts payable to suppliers, lease liabilities for Miami office
Office Meeting with Your Audit Manager
Ben Goldman: Good morning, team. I hope you're all doing well. How's the progress on last month's assignment?

Team Leader: Good morning, Ben. We've just concluded the assignment, and we're working on submitting the initial report for your review by the end of the working day today.

Ben Goldman: Excellent; I'll be looking forward to receiving that report. Now, let's discuss your next assignment: the Gabriela Aguiar LLC Audit, specifically the liabilities testing. Given the company's recent expansion and the importance of this audit, we need to pay extra attention to this area.

Team Leader: Understood. What specific areas should we focus on?

Ben Goldman: I'm glad you asked. I've done a quick scan of the trial balance, and I have some concerns about accounts payable. I need you to investigate a couple of things there.

Team Leader: What should we be looking for in accounts payable?

Ben Goldman: First, look for any AP that should have been written off according to the company's accrual policy. Second, search for unrecorded accounts payable. I have a hunch there might be some liabilities that haven't been reflected in the company's books yet.

Team Leader: Got it. We'll thoroughly review the AP. Anything else we should be aware of? Ben Goldman: Yes, there's an issue with legal fees. I just heard from Gabriela Aguiar, LLC's attorney. They're preparing the legal confirmation for us, but they mentioned $2.8 million in legal fees related to hurricane damage litigation that haven't been billed yet for 2025 work.

Team Leader: That's a significant amount. How should we approach this?

Ben Goldman: We need an interim report on this to ensure we're comfortable that liabilities are complete based on your search for unrecorded liabilities.

Team Leader: Understood. We'll look into that and include it in our report. Any other areas of concern?

Ben Goldman: Yes, there are some developments with notes payable and their line of credit. I spoke with the controller about the new debt. They took out a new loan of $15 million and rolled the $12 million from the line of credit into it, effective January 2, 2025. There's something about this in the Board of Directors' minutes, so make sure to review those.

Team Leader: We'll definitely review the minutes and follow up on that new debt arrangement.

Ben Goldman: Also, they started a new line of credit for $44 million on January 7, 2025.

Team Leader: That's a substantial new line of credit. We'll look into the details as well.

Ben Goldman: Good. Now, regarding leases, the controller assured me they don't have any capital leases. I've looked over the assets, and I'm inclined to agree. You don't need to spend too much time looking for these, but keep an eye out, just in case.

Team Leader: Noted. We'll do a quick check on leases but focus more on the other areas you've mentioned.

Ben Goldman: That's right. Oh, and one more thing: payroll-related liabilities are being tested with payroll, so you don't need to worry about them while you are testing.

Team Leader: Understood. Is there anything specific you'd like to see in our deliverables? Ben Goldman: Yes, I'd like you to prepare a comprehensive audit plan for liabilities, including your materiality calculations and planned procedures. I also want to see a liabilities lead

schedule, an AP aging schedule, and your initial findings on the potential issues I've mentioned.

Team Leader: We'll make sure to include all of those in our work.

Ben Goldman: Great. Once you've completed your testing, draft an interim report summarizing your findings, mainly focusing on any material issues or discrepancies you uncover.

Team Leader: Will do. We'll keep you updated on our progress and let you know if we encounter any significant issues.

Ben Goldman: Perfect. Do you have any questions or need any additional information to proceed?

Team Leader: I think we have a clear direction for now. We'll reach out if we need any clarification as we dig into the work.

Ben Goldman: Sounds good. I'm looking forward to seeing your results. Good luck with the audit, team.

Current Audit Context
This is the third year the FGCU-Accounting CPA firm has been engaged to audit Gabriela Aguiar LLC. The previous two audits resulted in unqualified opinions, but some control deficiencies in the accounts payable system were noted.

The current audit is particularly crucial as the Company is:

Seeking additional financing for its Caribbean expansion
Facing increased scrutiny from environmental regulators
Dealing with a recent change in the CFO position Specific Areas of Concern for Liabilities Testing:
Completeness and accuracy of accounts payable, given the previous control deficiencies
Proper classification and disclosure of long-term debt covenants
Accurate recording of lease liabilities, especially with the new Miami office
Potential unrecorded liabilities related to environmental compliance
The appropriate cut-off for liabilities pertaining to yacht manufacturing in progress
Instructions:
Read all memos from your manager and the client, then read the steps in the audit program for liabilities found on Work Paper F-0 (Excel Sheet labeled F-0 Liabilities Program) and familiarize yourself with work papers. Complete all the steps on the audit program. Be sure to document your work using the designated tick marks. The tick mark legend is located at the bottom of each work paper. When you are finished with each workpaper, enter your initials in the box in the top right.
Case Tasks:
Ethical Considerations: Consider the ethical implications of setting materiality levels and how it affects the audit process. Consider the AICPA Code of Professional Conduct and its relevance to this
Legal Exposure: Consider the potential legal risks auditors face when testing liabilities, especially if material misstatements are not
Risk Assessment: Consider the risks of material misstatement in the acquisition and expenditure cycle, focusing on
Materiality Calculation: Using the provided trial balance, calculate the overall materiality level for the audit. Explain your reasoning and
Liabilities Lead Schedule: Create a liabilities lead schedule based on the trial balance information.
Audit Procedures: Perform all audit procedures in the audit program (F-0) for testing liabilities. Evaluate the findings of these tests and propose adjusting entries as appropriate
Conclusion and Communication: Draft an email to the audit manager, Ben Goldman, summarizing your conclusion on liabilities testing. Include:
Key findings
Any identified misstatements or areas of concern
Recommendation for further action (if necessary)
Impact on the overall audit opinion
Additional Considerations:

Legal Exposure

Auditors face significant legal risks when testing liabilities, especially if material misstatements are not detected. If a company's liabilities are understated, investors or creditors could sue the audit firm for damages, claiming that they relied on the misstated financial statements. This is particularly relevant for a publicly traded company like Gabriela Aguiar LLC. The auditor's legal liability is often tied to the concept of negligence, where the auditor failed to exercise reasonable care in the performance of their duties. A lawsuit could allege that the auditor failed to perform necessary procedures to ensure the completeness of liabilities, which is a major concern noted by the audit manager.

Risk Assessment

The risk of material misstatement in the acquisition and expenditure cycle for Gabriela Aguiar LLC is high. Given the previous control deficiencies in accounts payable and the company's rapid expansion, the completeness assertion for liabilities is at high risk. There is a concern that not all liabilities have been recorded, as evidenced by the unbilled legal fees and the new debt arrangements. Additionally, the valuation assertion for accounts payable is at risk due to the possibility of unrecorded liabilities that may need to be estimated or accrued. The cutoff assertion is also at risk, as the timing of liabilities related to ongoing yacht manufacturing may not be properly recorded at year-end.

Materiality Calculation

Based on the provided trial balance, I will calculate materiality to guide the audit. A common benchmark for materiality is 5% of pre-tax income. However, given the lack of that information, other benchmarks like 0.5-1% of total assets, or 1-3% of total revenues could be used. Let's use total assets as the basis.

Total Assets: $300 million

Materiality %: Let's use a conservative 0.5% due to the high-risk environment.

Overall Materiality: $300,000,000 * 0.5% = $1,500,000

I would then calculate performance materiality, which is a lower amount used to determine the scope of audit procedures. A common percentage is 50-75% of overall materiality. Let's use 60%.

Performance Materiality: $1,500,000 * 60% = $900,000

The materiality level is set at $1.5 million. This figure is large enough to be practical but small enough to detect significant misstatements given the company's size and risk profile.

Liabilities Lead Schedule

A liabilities lead schedule would be created to summarize all liability accounts from the trial balance. It would include columns for:

Account Name (e.g., Accounts Payable, Notes Payable, Legal Fees Payable, Lease Liabilities)

Trial Balance (as of 12/31/2024)

Prior Year Audit Balance

Sample Answer

Given the role as a senior auditor for the Gabriela Aguiar LLC audit, the focus is on performing the liabilities testing as instructed. The following response outlines the steps to be taken, from ethical considerations to the final communication with the audit manager.

Ethical Considerations

The AICPA Code of Professional Conduct is crucial for setting materiality levels. The principle of due care is particularly relevant, requiring that auditors perform their work with competence and diligence. Setting an appropriate materiality level requires professional judgment and must be done to ensure that the financial statements are free of material misstatements. A level that is too high could lead to failing to detect significant errors, while one that is too low could make the audit inefficient. The principle of integrity is also vital, as the auditor must be straightforward and honest in all professional relationships. This means not bending to pressure from management to increase the materiality level to avoid detecting misstatements.