ch 14 SM FINALca - Solutions for Chapter 14 Audit of...

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Solutions for Chapter 14 Audit of Long-Term Liabilities, Equity, Acquisitions, and Related Entity Transactions Review Questions: 14-1. Audits of acquisitions and mergers are considered risky for the following reasons: it is often difficult to obtain objective evidence on the proper valuation of physical assets and liabilities acquired in the audit; for example appraisals of plant and equipment, or current value of liabilities, a number of accounts are valued based on subjective judgments – especially longer term liabilities such as warranties or pensions, many companies do not perform adequate due diligence in takeovers – a common form of merger – and often overpay for the company acquired, it is difficult to measure and quantify many of the intangible assets, goodwill must be valued and subsequently tested for impairment. Recent research shows that a high number of mergers have not been successful, although many have been. Some of the success stories include the mergers of public accounting firms, and of Exxon and Mobil. Major failures include the mergers that led to the formation of WorldCom. 14-2. Costs associated with a merger and the valuation issues are as follows: assets – valued are current market value. This is usually determined by an appraisal for fixed assets. Current assets are usually determined through normal audit-type procedures, e.g. estimating current market value of inventory, collectibility of receivables, etc. current liabilities – valued at market value. These are short-term liabilities. Typical audit procedures can be used to identify amounts eventually paid, or to discover unrecorded assets. The acquiring company can use these same procedures. longer-term liabilities – should be adjusted for changes in interest rate and credit rating of the company. Usually a ready market value is available. other liabilities (subjective) – The auditor must be aware of significant changes that might be made to pension plans or other benefit plans. If there are changes, the auditor should engage an actuary to assist in making the judgment. restructuring reserves – this has been a difficult area and one that has been subject to a great deal of manipulation by CFO’s. Often, companies have overestimated the
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reserves for restructuring with intent to subsequently take the items into income. Newer accounting rules make it more difficult to manipulate these accounts. 14.3. Goodwill is a residual that represents the excess of purchase price paid for an entity above the net fair market value of all other identifiable tangible and intangible assets. Goodwill may represent a number of things such as a superior marketing force, unique technology, or superior management associated with the acquired entity. The auditor should look at factors such as the time over which a competitive advantage is obtained because of the superior marketing distribution, advanced technology, or the skills of existing management. Goodwill should be analyzed for impairment every year.
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