ch 18 SM FINALca - Solutions for Chapter 18 Advanced Topics...

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Solutions for Chapter 18 Advanced Topics Concerning Complex Auditing Judgments Review Questions: 18-1. Yes, and in fact, it is the auditor’s obligation to question the acceptability of the client’s judgments. To evaluate the client’s judgments, the auditor should determine whether the client has a systematic process in place to evaluate the (a) the reasonable of the assumptions made in developing the estimate, (b) the quality of the data used in making the estimate, (c) the calculation of the estimate, and (d) the consistency of the estimate with prior year estimates and current economic conditions. The audit process should examine the four factors identified above, i.e. the assumptions, the quality of the data going into the estimation model, the nature of the calculations, and the consistency of the estimate. 18-2. The investors make some very important points, including the following: many of the estimates made in the past have not been very reliable, problems usually culminate over a period of time, so advance warning and some information on the development of problems would be very useful, companies ought to disclose contingencies that have the potential of a “severe” impact, regardless of the likelihood of outcome (auditors and managers do not seem to be very good at estimating likelihood of outcomes). The letters do a good job of reaffirming the need to understand materiality from an investor (user) perspective. 18-3. Yes, inventory, accounts receivable, and property, plant, & equipment are all subject to fair value estimates because all of these accounts are either subject to “lower of cost or market” considerations or impairment considerations. The lower of cost or market is used for both inventory and accounts receivable and requires management and the auditor to estimate the realizable (market) value of the assets. When plant and equipment are no longer being used, or are not being used productively, the auditor has to assess the potential decline in the value of the asset due to impairment – and that impairment is assessed through a market estimate of its value. 18-4. The Net Investment in Operating Leases represents the improvements and the investments made in property that the company leases, e.g. improvements to a building, or modifications made to equipment. Many textbooks refer to this account as “leasehold improvements.” Like all other assets, this account is also subject to impairment tests. If
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the company will no longer be using the assets under lease, then the net investment in the operating leases should be written down to its fair value. 18-5. Materiality decisions are complex and judgmental because they are a matter of professional judgment, depend on the needs of a reasonable person, which is obviously an ambiguous concept, and involve both quantitative and qualitative considerations.
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