Auditing and Assurance Services A Systematic Approach 10th Edition Messier Solutions Manual Download

Chapter 14 - Auditing the Financing/Investing Process: Prepaid Expenses, Intangible Assets, and
Property, Plant, and Equipment
Solution Manual for Auditing and Assurance Services A

Systematic Approach 10th Edition Messier Glover Prawitt
0077732502 9780077732509
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CHAPTER 14
AUDITING THE FINANCING/INVESTING PROCESS:
PREPAID EXPENSES, INTANGIBLE ASSETS, AND
PROPERTY, PLANT, AND EQUIPMENT
Answers to Review Questions
14-1 Prepaid expenses provide a legal right to services or an economic benefit for less than a
year. Intangible assets provide economic benefit for longer than a year, therefore
misstatements can occur which affect multiple periods.
Examples of prepaid expenses include:

 Prepaid insurance
 Prepaid rent
 Prepaid interest
Examples of intangible assets include:

 Copyrights
 Trademarks
 Trade names
 Licenses
 Patents
 Franchises
 Goodwill
 Computer software development costs
14-1
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
14-2 Intangible assets often present serious inherent risks because there are possible judgment
issues relating to the valuation and estimated lives of items such as patents, franchises, and
goodwill. These issues can lead to disagreements between the auditor and the client.
14-3 The purchasing process affects prepaid insurance and property, plant, and equipment
transactions because such transactions are subject to the control activities included in the
purchasing process. For example, control activities in the purchasing process may provide
assurance as to the proper authorization and recording of insurance policies. Similarly, the
occurrence (validity) and authorization of property, plant, and equipment transactions are
normally part of the purchasing process.
14-4 Examples of two substantive analytical procedures that can be used to test prepaid
insurance are:
 Compare the current-period balance in prepaid insurance and insurance expense with
the prior periods’ balances after considering any changes in operations.
14-2
 Compute the ratio of insurance expense to assets or sales and compare it with the prior
periods’ ratios.
14-5 A confirmation from insurance brokers would include information on the policy number,
coverage, expiration date, deductibles, and premiums.
14-6 The categories of intangible assets are (only four are required to be listed):
 Marketing—trademark, brand name, and Internet domain names.
 Customer—customer lists, order backlogs, and customer relationships.
 Artistic—items protected by copyright.
 Contract—licenses, franchises, and broadcast rights.
 Technology—patented and unpatented technology.
Four types of property, plant, and equipment transactions are:

 Acquisition of capital assets for cash or other nonmonetary considerations.
 Disposition of capital assets through sale, exchange, retirement, or abandonment.
 Depreciation of capital assets over their useful economic life.
 Leasing of capital assets.
14-7 a) Inherent risk factors to be considered when assessing inherent risk for intangible assets
are:
1. Nature of the judgments required to establish the assets value:
Considerable judgment is involved in valuing intangible assets acquired in a
transaction. Inherent risk may be reduced if a specialist was hired by the client
to assist in the valuation of the intangible assets.
2. Complexity of the accounting rules:
The complex rules with regards to acquisitions, tests for impairment, and
amortization of intangible assets with definite lives also increase inherent risk
because they require the entity to make assumptions regarding the assets
estimated value, life, or future cash flows.
3. Past or present disagreements with the client regarding valuation of intangible assets:
If there have been disagreements in the past with the client or there are current
concerns with the client’s valuation methods the auditor will increase the inherent
risk for the account so that any potentially material misstatements resulting from
improper valuation will be detected through the audit procedures.
14-3
b) Inherent risk factors that should be considered when assessing inherent risk for
property, plant, and equipment are:
1. Complex accounting issues:
Lease accounting, self-constructed assets, and capitalized interest are examples
of transactions that involve complex accounting issues.
2. Difficult-to-audit transactions:
The vast majority of property, plant, and equipment transactions are relatively
easy to audit. However, transactions involving donated assets, nonmonetary
exchanges, and self-constructed assets are more difficult to audit because it may
be difficult to verify the value of such assets.
3. Misstatements detected in prior audits:
If the auditor has detected misstatements in prior audits, the likelihood of
misstatements in the current year is higher.
14-8 Most entities have some type of authorization table for approving capital asset transactions.
Control activities should be present to ensure that the authorization to purchase capital
assets is consistent with the authorization table. For example, the control activities should
specify dollar limits at each managerial level to ensure that larger projects are brought to
the attention of higher levels of management for approval before commitments are made.
The entity also needs to have control activities for authorizing the sale or other disposition
of capital assets. This should include a level of authorization above the department
initiating the disposition. Control activities should also identify assets that are no longer
used in operations, because they may require different accounting treatment. Finally, an
appropriate level of management should properly authorize all major maintenance or
improvement transactions.
14-4
14-9 Some of the key segregation of duties for property, plant, and equipment and possible
errors or fraud that can occur if they are not present are:
Segregation of Duties Possible Errors or Fraud as a

Result of Conflicts in Duties
The initiation function should be Fictitious or unauthorized purchases of assets
segregated from the final approval could occur, resulting in purchases of
function. unnecessary assets, assets that do not meet
the company's quality control standards, or
illegal payments to suppliers or contractors.
The property, plant, and equipment A defalcation that would normally be
records function should be segregated detected by reconciling the subsidiary
from the general ledger function. records with the general ledger control
account could be concealed.
The property, plant, and equipment Tools and equipment could be stolen and the
records function should be segregated theft could be concealed by adjusting the
from the custodial function. accounting records.
If a periodic physical inventory of Theft of the entity's capital assets could be
property, plant, and equipment is concealed.
taken, the individual responsible for
the inventory should be independent
of the custodial and record-keeping
functions.
14-5
14-10 The following substantive analytical procedures can be used in the audit of property, plant,
and equipment:
 Compare prior-year balances in property, plant, and equipment and depreciation
expense with current-year balances taking into account any changes in conditions or
asset composition.
 Compute the ratio of depreciation expense to the related property, plant, and equipment
accounts and comparison to prior years' ratios.
 Compute the ratio of repairs and maintenance expense to the related property, plant,
and equipment accounts and compare to prior years' ratios.
 Compute the ratio of insurance expense to the related property, plant, and equipment
account and compare to prior years' ratios.
 Review capital budgets and compare the amounts spent with the amounts budgeted.
14-11 The following audit procedures can be used to verify the completeness, rights and
obligations, and valuation assertions:
Completeness: Physically examine a sample of capital assets and trace them into
the property, plant, and equipment subsidiary ledger.
Rights and Examine or confirm deeds or title documents for proof of

Obligations: ownership.
Valuation: Vouch additions and dispositions to vendor invoices or other

supporting documentation. Test depreciation calculations for a
sample of capital assets.
Answers to Multiple-Choice Questions
14-12 c 14-18 d
14-13 a 14-19 a
14-14 b 14-20 d
14-15 b 14-21 b
14-16 a 14-22 a
14-17 a
Solutions to Problems
14-23 a. Two substantive analytical procedures that can be used to test prepaid insurance are:
 Examine the trend in prepaid insurance over 3-5 years to develop an expectation
for the current year balance after considering any changes in operations. Compare
the expectation to the current-year balance and investigate the difference if it is
greater than the threshold.
14-6
 Compute the ratio of insurance expense to assets or sales and compare it with the
prior years’ ratios.
b. The following substantive tests should be performed on the schedule of prepaid

insurance:
 Foot the schedule and trace the ending balance to the prepaid insurance account in
the general ledger.
 Send confirmations to the entity's insurance brokers, requesting information on
each policy's number, coverage, expiration date, and premiums; alternatively,
examine supporting documents such as insurance bills and policies.
 Compare the detailed policies in the current year's insurance register with the
policies included in prior years' insurance register.
 Recompute the unexpired portion of the prepaid insurance after considering the
premium paid and the term of the policy.
 Examine the insurance policy coverage and ensure that costs are properly allocated
to the various insurance expense accounts.
 Inquire of management or its insurance broker about the adequacy of the entity's
insurance coverage.
14-24 a. Taylor should consider performing the following procedures in the audit of Palmer's
goodwill and trademark accounts:
 Obtain a copy of the entity’s detailed listing of intangible assets, which should agree
with the total amount of intangible assets reported on the entity’s balance sheet.
 Examine the entity’s impairment documentation to ensure that each asset is subject
to the appropriate impairment testing in accordance with GAAS including the
goodwill and trademark accounts.
 If impairment tests have not been performed on the goodwill and trademark
accounts, the auditor would establish the fair value of all assets and liabilities of the
reporting unit using an appropriate valuation model consistent with GAAP. A
qualified, objective specialist may be employed to assist in this process.
 The excess fair value of the reporting unit’s assets over liabilities is the implied fair
value of goodwill. Verify if goodwill is impaired, and if so, verify if the amount of
impairment loss is material.
 The result of the valuation of the trademark assets is compared with the current
book values of the trademark assets to verify if the assets are impaired.
 If the trademark assets are impaired, verify if the amount of the impairment exceeds
materiality.
14-7
b. When specialists are used, the auditor is required to evaluate the specialist’s
qualifications and objectivity. The auditor also must determine if the valuation model
used by the specialist is appropriate and consistent with GAAP and the auditor must
understand and agree with the reasonableness of the underlying assumptions.
14-25 The key internal controls related to Grant's property, equipment, and related transactions
that Nakamura may consider in assessing control risk include the following:
 Advance approval in accordance with management's criteria is required for property
and equipment transactions.
 Approval authority for transactions above an established dollar value is required at a
higher level, such as the board of directors.
 Property and equipment transactions are adequately documented.
 There are written policies covering capitalizing expenditures, classifying leases, and
determining estimated useful lives, salvage values, and methods of depreciation and
amortization.
 There are written policies covering retirement procedures that include serially
numbered retirement work orders, stating the reasons for retirement and bearing
appropriate approvals.
 There are adequate policies and procedures to determine whether property and
equipment are received and properly recorded, such as a system that matches purchase
orders, receiving reports, and vendors' invoices.
 There are adequate procedures to determine whether dispositions of property and
equipment are properly accounted for and any proceeds are received in accordance with
management's authorization.
 A property and equipment subsidiary ledger is maintained showing additions,
retirements, and depreciation, and the ledger is periodically reconciled.
 Property and equipment is physically inspected and reconciled at reasonable intervals
with independently maintained property and equipment records.
 An annual budget is prepared and monitored to forecast and control acquisitions and
retirements of property and equipment.
 Reporting procedures ensure prompt identification and analysis of variances between
authorized expenditures and actual costs.
 Adequate safeguards protect property and equipment.
 Property and equipment are insured in accordance with management's authorization.
 Documents evidencing title and property rights are periodically compared with the
detailed property records.
 The entity employs internal auditors to test whether the internal controls are operating
effectively.
14-8
14-26 a. Property, plant, and equipment normally include only fixed tangible assets. Fixed
tangible assets are capital assets with useful lives generally in excess of one year that
are used in the operation of the business and that are not purchased for resale purposes.
In connection with the examination of property, plant, and equipment (PP&E), the
auditor must be satisfied that:
 Internal controls over PP&E and PP&E acquisitions are adequate.
 Assets included in PP&E exist and are being used in the normal operations of the
business.
 Assets included in PP&E are owned by the company whose financial statements
are being examined.
 Assets included in PP&E are not encumbered by liens or, if so, the facts are properly
disclosed in the footnotes to the financial statements.
 Depreciation and/or amortization methods are proper.
 Amounts in the financial statements are in substantial agreement with the
supporting records.
 Accounting for additions, disposals, and retirements is proper.
 Maintenance accounts do not include items that should be capitalized.
 The valuation and the disclosure of the method of evaluation are acceptable.
 Important information relating to the assets is properly disclosed.
b.
Item Is Audit Adjustment Reasons Why Audit Adjustment or

Number or Reclassification Reclassification Is Required or Not Required
Required?
Commissions paid to real estate agents are costs
1. Yes directly related to the acquisition of the property
and should be included in the land cost. The
costs of removing, relocating, or reconstructing
property of others to acquire possessions are
costs that are directly attributable to conditioning
the property for use and should be included in
land costs. An adjustment is required for these
items so that total land costs can properly be
included in property, plant, and equipment.
2. No No adjustment is required because clearing costs
are costs that are directly attributable to
conditioning the property for use and should be
included in land costs, which are part of
property, plant, and equipment.
3. Yes Since clearing costs are costs of the land,
amounts realized from the sale of materials
recovered, such as timber and gravel, should be a
reduction of the cost of the land and should not
14-9
be recorded as other income.

4. Yes All costs relating to the purchase of machinery
and equipment should be capitalized. For
purchased items such costs would include
invoice price, freight costs, and unloading
charges. Royalty payments, however, should not
be included in the cost of the machinery. Such
payments should be charged to expenses as they
accrue. Machinery costs, other than royalty
payments, should be included in property, plant,
and equipment.
14-27 a. 4
b. 7
c. 2
14-28 Substantive audit procedures that Pierce should use in examining Wong's mobile
construction equipment and related depreciation would include the following:
 Determine that the equipment account is properly footed.
 Determine that the subsidiary accounts agree with controlling accounts.
 Obtain, or prepare, an analysis of changes in the account during the year.
 Determine that beginning-of-year balances agree with the prior year's ending balances.
 Inspect documents in support of additions during the year.
 Inspect documents in support of retirements during the year.
 Analyze repairs and maintenance for possible reclassifications.
 Determine the propriety of accounting for equipment not in current use.
 Test the accuracy of equipment and accounting records by (1) selecting items from the
accounting records and verifying their physical existence and (2) selecting items of
equipment and locating them in the accounting records.
 Evaluate the reasonableness of estimated lives and methods of depreciation used.
 Test the calculation of depreciation expense and accumulated depreciation balance.
 Perform analytical procedures such as comparing depreciation expense to balance sheet
accounts for proper relationship and compare the current year's depreciation expense
with prior year's depreciation expense.
 Evaluate the financial statement presentation and disclosures for conformity with
generally accepted accounting principles.
 Review insurance coverage.
14-10
Solution to Discussion Case
14-29 a. The relevant accounting standard for this is found in FASB ASC Topic 360-20, "Real
Estate Sales." Under the standard, full recognition of profit requires that (1) the profit
is determinable and (2) the earnings process is virtually complete. The standard further
requires that a sale is not consummated until (1) the parties are bound by the contract,
(2) all consideration has been exchanged, (3) any permanent financing for which the
seller is responsible has been arranged, and (4) all conditions precedent to the closing
have been performed (paragraph 6). Because no closing has taken place, Leno's
transaction should not be accounted for under the full accrual method. Thus, Leno must
account for the transaction using another method.
The accounting standards provide a number of alternative approaches for
recognizing revenue, including (1) the deposit method and (2) the cost recovery
method. Under the deposit method, no profit is recognized because the sale has not
been consummated. The cost recovery method can be used if the receipt of the
irrevocable letter of credit is treated as a separate transaction from the total sales
transaction and profit is recognized on this portion of the transaction independently of
the remainder of the transaction. It could be argued that the first transaction (the receipt
of the letter of credit) meets the requirements of FASB ASC Topic 360-20 because (1)
profit on the transaction is determinable and collectability is assured and (2) the seller
has earned the profit as evidenced by the fact that Leno can keep the proceeds from the
letter of credit as well as the property if the buyer does not consummate the transaction.
It can also be argued that the criteria in paragraph 5 have been met for this portion of
the transaction, since it meets the requirement of an adequate initial investment (greater
than 15% for commercial and industrial property). Following the cost recovery method
at March 31, 2013, a gain of $1,580,000 would be recognized on the difference between
the book value of the property and the amount of the irrevocable letter of credit. The
property would be removed from Leno's balance sheet, and the letter of credit would
be presented as a "deposit received under contract of sale."
b. Prior to recognizing any gain on the transaction, the auditor should:

 Examine the sales contract.
 Examine the letter of credit.
 Obtain a confirmation from the bank on the terms of the letter of credit.
 Examine the subsidiary records containing the information on the land and
building's book value.
 Examine financial information on the buyer to determine its financial position.
14-11
Solutions to Internet Assignments

14-30 It is difficult to get information directly on some of EarthWear’s competitors. While
Lands’ End was formerly a stand-alone public company, it is now part of the Sears Holding
Corporation. The Sears’ annual report indicates that it uses a straight-line method over the
estimated useful lives of the respective assets for financial statement purposes and
accelerated methods for tax purposes. For example, Sears’ uses 3 to 5 years for computer
systems and equipment.
VF Corporation has apparel brands such as Vans, Wrangler, Timberland, Lee Jeans,
The North Face, JanSport, Nautica and Eastpak. VF Corporations 10-K states,
“Depreciation of owned assets is computed using the straight-line method over the
estimated useful lives of the assets, ranging from 3 to 10 years for machinery and
equipment and up to 40 years for buildings. Leasehold improvements and assets under
capital leases are amortized over the shorter of their estimated useful lives or the lease
terms.” Eddie Bauer, L.L. Bean and Patagonia are privately held companies and there are
no publicly available financial statements.
14-31 A search of the SEC’s website should identify a company that has been recently cited by
the SEC for problems related to property, plant, and equipment.
14-12

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Chapter 14 - Auditing the Financing/Investing Process: Prepaid Expenses, Intangible Assets, and

Property, Plant, and Equipment

Solution Manual for Auditing and Assurance Services A

Answers to Review Questions

Examples of prepaid expenses include:

Examples of intangible assets include:

Four types of property, plant, and equipment transactions are:

Segregation of Duties Possible Errors or Fraud as a

Rights and Examine or confirm deeds or title documents for proof of

Valuation: Vouch additions and dispositions to vendor invoices or other

Answers to Multiple-Choice Questions

b. The following substantive tests should be performed on the schedule of prepaid

Item Is Audit Adjustment Reasons Why Audit Adjustment or

be recorded as other income.

Solution to Discussion Case

b. Prior to recognizing any gain on the transaction, the auditor should:

Solutions to Internet Assignments

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