Billy's Research Questions

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- There were concerns about the Valuation & Allocation and Classification of the plant and equipment acquired by Little Drummer Boy, Inc. The percentage of the seller’s total cost was applicable to each respective asset class, determined by the external specialist and agreed by the management of Little Drummer Inc.

- The Audit team made a spreadsheet listing and comparing the asset ID, asset class, and percentage of total costs to test both valuation and allocation and classification

- No errors found, and nothing else was tested.

- The engagement team perform neither adequate procedures on valuation and allocation assertion nor appropriate procedures on right and obligation assertion on the acquisition of Little Drummer. The auditor can test for rights or ownership by confirming property deeds and title documents for proof of ownership. For valuation and allocation, the auditor should test depreciation calculations for a sample of capital assets and evaluate fixed assets for significant write-offs or impairments by performing procedures such as:

- Identify the event or change in circumstance indicating that the carrying value of the asset may not be recoverable.

- Verify impairment loss by determining the sum of expected future cash flows and comparing that sum to the carrying value.

- Examine client documentation supporting impairment of write-off.

NOTE 4-GOODWILL AND OTHER INTANGIBLE ASSETS

- After Billy’s acquired Little Drummer and RockOut acquired five guitar companies during 201X, judgment was required to initially value assets such as trademarks, customer lists and goodwill. The inherent risk of significant intangible assets was high because of the judgment and complexity associated with valuation and impairment testing of them.

- Due to large-scale acquisitions, the Company’s business acquisition processes that included intangible asset transactions and initial valuation were significant for the audit of internal controls over financial reporting. Thus, the control risk was moderate and the control activities should make sure that all identifiable asset categories were separately valued and that the external valuation specialists used by the Company were qualified and objective, involving both existence and completeness, valuation and classification assertions. The auditor might also assess the extent to which the Company engages valuation specialists, the significant management assumptions used in determining fair value and controls over data and segregation of duties between those committing the entity to the purchase and those undertaking the valuation. Moreover, the control activities for impairment testing were necessary, possibly consisting of annual testing process, the company’s relevant policies and procedures and verification in compliance with GAAP.

a. Acquisitions of customer lists by RockOut

RockOut reported $90 million in customer lists which was 60% of intangible assets and 15% of total assets during the acquisitions in 201X. Customer lists had been amortized over 25 years on a straight-line basis since management thought that this was the pattern of which the economic benefits were completed. In 201X, management changed the estimate of customer list amortization life to be 15 years to lists that were newly acquired. The amortization expense for December 31, 201X was $3 million. RockOut acquisition of guitar companies, notably the customer lists, where there was a difference between the amortization lives of current-year customer list additions and the accumulated balance of customer lists from previous years.

- Valuation was the most important assertion associated with the acquired customer lists. Management asserts that the newly acquired customer lists within the current year were listed with accurate economic lives, even though they were 10 years shorter that the economic lives of the customer lists that they had before the current year. The economic benefits to be received would be completed by the time the stated economic useful life of the respective assets runs out.

- Audit team tested the reasonableness of the economic lives of customer lists by inquiring management about the reasoning for the change in economic lives.

- Management gave them a memo explaining the justification for using 25-year life, as well as the reasoning for the change in estimate of this current year.

- This memo was put in the audit working paper, but had no additional notes for the audit team.

b. The audit team perform failed to perform adequate procedures on valuation assertion on the acquisitions of customer lists by RockOut. The auditor should also evaluate the external specialist’s qualifications and objectivity and determine if the valuation model used by the specialist was appropriate and consistent with GAAP (either for initial valuation or after an impairment).

REFERENCE LIST

IFRS in Focus Newsletter IASB issues new standard on fair value measurement and disclosure summarising the requirements of IFRS 13 (PDF 78k, May 2011)

FASB ASC Topic 350