Auditing Special Purpose Frameworks: Auditing Investments—Part 2by
In my last article, I summarized major differences between principles in U.S. GAAP and the Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SMEs). In this article, we will begin to consider the effects of these differences on auditing procedures for intangibles and investments.
Goodwill and Indefinite-Lived Intangibles
FRF for SMEs Accounting Principles. Goodwill may be amortized using the federal income tax time period or 15 years. All definite-lived intangible assets will be assigned estimated useful lives and amortized over that period. Intangibles acquired in business combinations will be recognized separately from goodwill if they are separable and have an identifiable useful life, and if a market value can be determined. Otherwise, they are accounted for as a part of goodwill.
No tests for impairment are required for long-lived assets, tangible or intangible. Such tests are performed only in response to triggering events that may impair their carrying amounts, such as bankruptcy of the entity from which intangible assets were acquired in a business combination or new technology that reduces the value of existing equipment. Impairment losses are recognized when necessary. Any long-term assets no longer used are written off. Management may elect either to expense development phase intangibles or to capitalize their costs.
FRF for SMEs Auditing Procedures. Auditing goodwill and intangibles will include two significant steps:
- Determining any triggering events that could cause impairment of the assets.
- Evaluating the assets' useful lives and amortization methods.
The determination of events triggering impairment will occur as a result of performing these and other auditing procedures:
- Delivery and discussion of the engagement letter by the engagement leader. The engagement leader will normally make inquiries about the current operating results of acquired entities from which the intangibles were acquired, in addition to asking other questions about the reporting entity's overall business and environment. Current financial statements of the acquired entities should be reviewed during these discussions.
- Amortization rates and methods should be tested in accordance with the engagement audit strategy.
- The accounting for any business combinations during the period should be audited to determine that goodwill and intangibles are calculated and recorded properly in accordance with the principles of the FRF for SMEs.
FRF for SMEs Accounting Principles. Investments in entities over which a company has significant influence are accounted for under the equity method. All other investments are accounted for based on historical cost, except for securities held for sale, which are valued at market value (changes are included in income). Income from investments should be presented separately or disclosed in the footnotes.
Equity method investees should follow the same method of accounting as the investor; in other words, appropriate adjustments should be made in accounting for an investor's share of an investee's income if reporting frameworks or accounting principles are different. An entity's share of any discontinued operations, changes in accounting policies, or corrections of errors and capital transactions of an equity method investee should be presented and disclosed separately.
FRF for SMEs Auditing Procedures. Investments accounted for under the cost method are recorded at their purchase costs. Dividends, interest, or other income are recorded in income as received or accrued. As they would be for any reporting framework, brokers' statements, purchase receipts, contracts, or other documentation would be inspected by the auditor in the period of acquisition; evidence of continuing ownership should be inspected in subsequent years. Income received or receivable should be traced to appropriate support.
Any dividends issued out of investee capital should be recorded as reductions of the cost of the investment. The auditor should also make inquiries of management and persons charged with governance, and perform appropriate research to determine there are no triggering events that could cause the carrying amount of the investments to be permanently impaired.
For investments accounted for under the equity method, auditors should inspect documentation supporting the purchase cost in the year of acquisition of the investment. Since the equity method can only be used when the investor has significant influence over the investee, the auditor should consider these and other matters:
- Representation on the board of directors of the investee.
- Participation in policy-making processes.
- Material intercompany transactions.
- Interchange of managerial personnel.
- Technological dependency.
- Concentration of other shareholdings, such as a larger number of smaller shareholders.
When the investor has significant influence over the investee, normally an investment interest of 20 percent to 50 percent, the equity method may be used under the FRF for SMEs. Under the equity method, the investor's proportionate share of the investee's periodic income should be recognized in its statement of operations. Depending on the materiality of the investor's share of investee income reported in its statement of operations, the auditor should perform appropriate procedures to audit the income amount.
For less material amounts of income, at a minimum, the auditor should read financial statements of the investee to determine where they are appropriate under the investee's applicable financial reporting framework. For material amounts of investee income recorded in the investor's income, a review or audit of the financial statements may be required.
The auditor should also determine that appropriate adjustments have been made to income amounts, including eliminating intercompany gains and losses, amortizing any difference between the investor's cost and the underlying equity in the net assets of the investee, and making adjustments of differences in the investee's applicable reporting framework if necessary. As under the cost method, the auditor should also determine if any triggering events have occurred that could cause impairment of the carrying amount of the equity method investment.
Other Resource Materials
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