Efficient Tests of Balances Series—No. 23: Auditing Goodwill, Intangibles and Deferred Charges
For most entities, auditing procedures for goodwill, intangibles and deferred charges will be performed during tests of balances. While management has primary responsibility for recording and periodically measuring these intangible assets, the auditor has responsibility for determining the reasonableness of management’s processes and their valuations of these assets. Realistically, managements of small to medium-size entities often don’t have the training or experience to make such valuations. In these cases, the services of outside specialists may be necessary. To avoid the impairment of the auditor’s independence, the auditor’s valuation of intangibles must be supervised and approved by client personnel possessing suitable skill, knowledge and/or experience.
Two auditing standards are specifically applicable to goodwill, intangibles and deferred charges:
• AU Section 328, www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00328.pdf , Auditing Fair Value Measurements and Disclosures
• AU Section 342, www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00342.pdf , Auditing Accounting Estimates.
The principal issues in AU Section 328 affecting goodwill and intangibles would be connected with the initial and subsequent valuation of net assets received in business combinations under the acquisition method of accounting along with the related goodwill and intangibles. At each reporting date:
1. The auditor must evaluate the reasonableness of management’s calculation of fair values of assets, liabilities and non-controlling interests in consolidated entities and the related goodwill and intangibles not being amortized or,
2. if management can’t or doesn’t make such calculations, request the client hire a specialist or
3. request a client employee with suitable skill, knowledge or experience be assigned to oversee the valuation process performed by the auditor.
When the fair values of goodwill or intangibles are less than their carrying amounts, an impairment loss should be recognized in the income statement.
For AU Section 342, the principal issues relate to amortized intangibles and their amortization methods and their assigned useful lives. The auditor must determine that these estimates are reasonable and appropriate in the client’s circumstances. Impairments in the values of these intangibles may result in impairment losses being recognized in the income statement. Every auditor should have copies of AU Sections 328 and 342 to read and study in their entirety.
Efficient substantive procedures for goodwill, intangibles, deferred charges and other account classifications resulting from cost-beneficial audit strategies are discussed in my live and on-demand webcasts which can be accessed by clicking the applicable box on the left side of my home page, www.cpafirmsupport.com.