Week 4 Case Hand-In Requirements

I. Read the Hammersley Academic Research Paper Auditing Estimates: A task analysis and answer the
questions below. (Why does the audit of estimates present unique challenges for the auditor?)

1) Briefly summarize the 3 high-level requirements the auditor must follow as per the audit
standards.

Answer:

Auditing standards need auditors to find areas or accounts that may contain significant
estimates, evaluate the reasonableness of estimates, and conclude whether estimates contain
material misstatements.

2) How does the auditor evaluate the reasonableness of estimates (where do they start and what 3
possible approaches can they use)?

Answer

To evaluate the reasonableness of estimates, the standards require that auditors take one or
more of the following three approaches:
a. test the clients process for generating estimates;
b. develop independent expectations of estimates; and/or
c. review subsequent events and transactions that provide evidence relevant to estimates.

3) Which approach do the auditors in the study note as being used most often?

Answer
They rarely develop independent expectations or review subsequent events data to evaluate
the reasonableness of estimates; instead they most often opt to test the clients process for
generating complex estimates.

4) What big picture errors do the authors note, based on their interviews and investigations, that
auditors most often make?

Answer
Auditors sometimes make big picture errors such as failing to understand the process that
generates the representations, being insufficiently skeptical about the source of the numbers,
and failing to adequately assess the reasonableness of significant assumptions. In addition,
auditors sometimes fail to notice troublesome patterns of data (e.g., objective external data
conflicts with client projections) or fail to adjust for changing circumstances (e.g., economic
conditions
 5) Where do auditors typically encounter problems in the audit of estimates?

Answer
Auditors experience problems throughout the process of auditing estimates. These problems
include Over-relying on managements assertions and failing to notice inconsistencies among
data, assumptions, and external evidence. These problems indicate that insufficient professional
skepticism is an underlying cause of poor auditor judgment in auditing estimates.

6) How do experience related problems impact auditor effectiveness in auditing estimates?

Answer

Inexperienced auditors frequently lack sufficient knowledge of U.S. GAAP as it pertains to

auditing estimates, lack of knowledge in how to proceed in auditing estimates and have
difficulty in maintaining adequate skepticism and objectivity.These experience-related problems
are notable in that they affect all steps in the process of auditing estimates

II. Complete the questions related to the audit of the Broadcast license at Wasatch Corp. (Part III)

Wasatch Corp. Part III Intangible Asset Broadcast License 2013 KPMG LLP

Assume that upon inquiry, you learn the following about Wasatchs second investment, the
Broadcast License. Read the information below, then answer the questions.

During the meeting, Mr. Bigfet also informs you that Wasatch, Corp. acquired a new business, Borealis
Company effective December 31, 20X0, valued by a specialist using an income method, discounted cash
flow technique. Borealis was a major competitor in the Great Northwest Territory and the broadcast
license was their primary asset. When you ask what Wasatch is doing with this asset, Mr. Bigfet says that
when they purchased Borealis, he had hoped to use this broadcast license to further gain market share in
another part of the world. But, recently, has says, they have decided not to pursue broadcasting in this
market. Mr. Bigfet also says that they have not examined the broadcast license for possible impairment.

Further investigation revealed that Wasatch Corp purchased the intangible asset, which gives it
broadcasting rights in the future. When acquired it was determined that the broadcasting rights result in
cash flows of $500,000 at the end of each year for the next seven years. The risk-free interest rate is 4%;
the receipt of these franchise cash flows is not certain, so a 10% risk- adjusted rate is determined specific
to this franchise.

In addition, you remember reviewing the compensation contracts of key employees and you know that the
last thing Mr. Bigfet needs is an asset impairment loss that would keep him from getting his bonus this
year. However, you have read a recent article in The Economist that indicates the Great Northwest
Territory has entered a recession due to global warming and there may not be much market share left as
people are moving elsewhere.
Questions:

a) Describe the nature of the asset. Do you agree that it is a financial asset? If not, what type of
asset is it?
Answer:
The broadcasting License is an intangible asset and not a financial asset since its vale is
not being derived from a contractual claim such as stocks or bonds value is derived from a
contractual claim.

b) What is the RMM for this asset?

Answer:
The Revenue is currently being recognized on an estimate basis in respect of the
franchise. The estimate may be biased and not based on realistic assumptions regarding the actual
market position.

RMM= Moderate,

Since Inherent risk is moderate due to moderate level of judgement is involved in asset
acquisition and control risk is low since management identified correctly the shortcoming
associated with asset purchase.

c) What approach is management using to estimate the FV of this asset? What level in the input
hierarchy are they using?

Answer:

The management is using Income Approach and second level of input hierarchy, to estimate the
FV of this asset as they are using estimated future cash flows and inputs other than quoted prices
e.g. interest rates

d) What audit testing approach should the auditor use to test the valuation of this asset summarize
the specific procedures the auditor should perform.

Answer:
The auditor should use a good mix of following testing approaches;

1. Risk Assessment Procedures

Collectively, procedures performed to obtain an understanding of the entity and its environment,
including internal controls and assessment of the risk of material misstatement in the financial
statements.
2. Tests of Controls
To assess control risk for each transaction-related audit objective.

3. Substantive Tests of Transactions

To determine whether all six transaction related audit objectives have been satisfied for each class
of transactions
e) What are the significant inputs & assumptions with this asset that need to be evaluated? For each
input or assumption, summarize the procedures the auditor could perform to audit these.

Answer:

The cashflows of $500,000 for correct estimations, Asset valuation for the purchasing price
and impairment loss to the management are needed to be evaluated using tests of controls,
Substantive tests of transactions and Audit risk assessment techniques.

f) What issues or concerns do you have with managements valuation approach or assumptions
used?

Answer:

The management may have concealed actual acquisition price since the loose structure of
Internal Control also they have not measured impairment loss so the actual value might be faulty
secondly the management is giving misstated information about the market which can affect the
measurement of cash flows and profits.