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Chapter14AuditofAcquisitions,RelatedEquityTransactions,Long-TermLiabilities,andEquityReviewMergersandAcquisitionsTherearethreevaluationissuesassociatedwithacquisitions:ValuingtheassetsandassociateliabilitiesuponacquisitionMeasuringrestructuringchargesandrecognitionoftheliabilityMeasuringimpairmentofassetsafteroperationbeginsDiscussAcquisition-AssetValuationIssuesMajorissuesassociatedwithvaluinganacquisitionare:DeterminingthecostoftheacquisitionValuingidentifiabletangibleandintangibleassetsandliabilitiesValuinggoodwillCommentonDeterminingtheCostoftheAcquisitionNormally,costisamountpaidtoacquirethecompanyHowever,therearethingsthatmaketheassessmentmorecomplicated:AcquisitionsmadeusingstockratherthancashWherethefinalpriceiscontingentontheassetsreceived(post-audit)Wherethefinalpriceiscontingentonacquiredentity'sperformanceAuditormustassesslikelihoodofacquiredentitymeetingperformanceobjectives-ifhighlylikely,thefullcostshouldberecognizedatthetimeofacquisitionValuingIdentifiableTangible&IntangibleAssets&LiabilitiesAcquiringcompanyrecordsassetsattheirfairmarketvalueattimeofacquisition:CompanyusuallyhiresappraisertovaluetangibleassetsIntangiblesshouldbevaluedatnetpresentvalueoffuturecashflowsAuditorcannotsimplyacceptappraisalandmanagement'sassessmentoffairvalueofassetsAuditormustgatherindependentevidencetodeterminewhetherassessedvaluesareappropriateAuditormayrelyonthespecialisthiredbymanagementorhiretheirownspecialist.Eitherway,theauditorshould:EvaluatequalificationsofthespecialistDetermineifspecialistisindependentofmanagementReviewthemethodologyusedbythespecialistHowdoyouvaluegoodwill?GoodwillistheexcessofpurchasecostoverthefairmarketvalueoftangibleandintangibleassetsacquiredinapurchaseSFAS142requiresgoodwillbespecificallyidentifiedwithanoperatingorreportingunitImportantsogoodwillcanbetestedforimpairmentonanannualbasisValuationandtestingofimpairmentisfacilitatedifcompanyusescapitalbudgetingprocessDiscussRestructuringChargesWhencompaniesrestructureoperations,GAAPrequirescompaniesrecognizethecostofrestructuringandassociatedliabilitiesTheauditorshouldexaminerestructuringchargesthoughtheseprocedures:ReviewFASBpronouncementsandEITFstatementsReviewhowcompanyestimatedrestructuringchargesReviewactionstakenbymanagementthatindicaterestructuringhasmovedbeyondaplanTestestimatesbyreviewingcontracts,propertyappraisals,severancecontracts,andotherrestructuringdocumentsMathematicallytestestimatesDevelopconclusionastoreasonablenessofliabilityandappropriatenessofclientaccountingCommentonTestingforGoodwillImpairmentGAAPrequiresgoodwillmustbetestedeveryyearforimpairmentThecompanymustdeterminethefairmarketvalueofthereportingunitandcompareittothereportingunit'scarryingvalue(includinggoodwill)Iffairmarketvalueislessthancarryingvalue,itisinferredthatgoodwillhasbeenimpairedandmustbewrittendownThereportingunitmaybethecompanyorasub-unitofthecompanyTheauditormustevaluate:Management'smethodologyforassessingimpairmentWhetheranobjectiveevaluationsupportstheclient'sconclusionAnnualAudits:RiskFactorsandGoodwillImpairmentInadditiontotheannualreview,situationsmayarisewhichimpairgoodwill:SignificantadversechangeinlegalfactorsorthebusinessenvironmentAdverseactionorassessmentbyregulatorUnanticipatedcompetitionthatsignificantlyreducesvalueofcompany'sproductsSignificantlossofkeypersonnelExpectationthatreportingunitwillbedisposedofSignificantassetgroupwithinareportingunittestedforrecoverabilityImpairmentrecognizedbysubsidiaryAudittestsforgoodwillimpairmentwillrequireconsiderablejudgmentandbusinessknowledgeReviewTransactionswithRelatedPartiesRelatedpartytransactionshavebeenusedtomanipulatefinancialreportingandshould,therefore,beconsideredhighriskAuditormustconsiderthataclientmaynotwanttohaveitsrelatedpartytransactionsdiscoveredTouncoverthesetransactions,theauditorwill:Obtainalistofallrelatedparties;thendevelopalistofalltransactionswiththosepartiesCarefullyexamineallunusualtransactionstodeterminewhetherthetransactionsinvolvedarelatedpartyTheauditortheninvestigatesthetransactionstodetermineiftheyhavebeenproperlyrecordedanddisclosedDiscussAuditsofLong-TermLiabilitiesandOwnersEquityLiabilitieswithsignificantsubjectivejudgments:RestructuringreservesWarrantyreservesPensionobligationsOtherpost-retirementbenefitsDefine&ExplainWarrantyReservesThewarrantyreserverepresentsexpectedfuturecostrelatedtosalesofacompany'sproduct;itisestimatedandrecordedwhentheproductissoldTheestimateistypicallybasedonpastexperienceofthecompanyandadjustedforChangesintheproduct,includingthosethatchangeitsqualityChangesinthewarrantyChangesinsalesvolumeChangesintheaveragecostofrepairingproductsunderwarrantyTheauditorcanexaminetheaccountbyTestingtheinformationsystemusedbytheclientDevelopinganestimatebasedonthefactorsabovePensionObligationsTheamountofpensionobligationsarebasedonanumberfactors:EstimatedlifetimeofpensionersFutureearningsofemployeespriortoretiringEarningsrateoninvestedpensionassetsLong-terminterestratesusedtodiscountfuturecostsChangesinpensionplansTheclientwillusuallyhireanactuarialfirmtohelpmaketheestimatesTheauditormustdeterminethattheactuarialfirmisindependent,competent,andhassufficientreliableinformationtodeveloptheestimatesDiscussBonds&Stockholders'EquityCompaniesissuecapitalstock(equity)andbonds(borrowing)toraiselong-termfundsOtherfinancingactivityaccountsinclude:NotespayableMortgagespayableContractspayableSpecialbondsPayment-in-kindbondsConvertiblebondsMandatoryredeemablepreferredstockStockoptionsandwarrantsStockoptions-employeestockcompensationprogramExplainAuditingBondsPayableBondsareissuedtofinancemajorexpansionsorrefinanceexistingdebt.Whilebondissuesareinfrequent,eachtransactionismaterialPrimaryconsiderationsinauditingbondsorotherlong-termdebt:ValuationandamortizationofpremiumordiscountAuditorwillreviewloandocumentsIfdebtisissuedduringtheauditperiod,receiptofcashmaybetracedtocashreceiptsjournalandbankPrincipalpaymentsmaybetracedtothedisbursementsjournalAuditormayconfirmyear-endbalanceswithdebtholdersComputationofinterestexpenseAuditorwillusuallyrecalculateinterestexpenseincludingamortizationofanydiscountorpremiumAccountingforgainsorlossesondebtrefinancingDisclosureofmajorrestrictionsinbondindenturesAuditortypicallyreviewsloandocumentsandmakesinquiriesofclientExplainAuditingBondsPayableDiscussCommon
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