THEORY QUESTIONS

1. The most effective means for the auditor to determine whether a recorded
intangible asset possesses the characteristic of an asset is
a. Vouch the purchase by reference to underlying documentation.
b. Inquire as to the status of patent application.
c. Evaluate the future revenue-producing capacity of the intangible asset.
d. Analyze the research and development expenditures to determine that only those
expenditures possessing future economic benefit have been capitalized.

2. In auditing Intangible Assets, an auditor most likely would review or recompute

amortization and determine whether the amortization period is reasonable in support of
management’s financial statement assertion of
a. Valuation and allocation
b. Existence
c. Completeness
d. Rights and Obligations

3. Assuming NL has capitalized all research and development cost associated with patent,
Jon, CPA, who is examining this account will probably
a. Confer with management regarding the transfer of the amount from the balance
sheet to the income statement
b. Confirm that the patent is registered and on the file with the intellectual property
office
c. Confer with management regarding a change in the title of the account to
“goodwill”
d. Confer with management regarding ownership of the patent

4. There is goodwill involved in the acquisition of a business if the purchase price paid is in
excess of the proprietorship of the business acquired.
Goodwill might be viewed as the employment of a profit by a company in excess of
the normal or usual return for the industry as a whole but such goodwill is not
recorded if it has not been purchased or paid for.
a. False;True
b. False; False
c. True;False
d. True;True

5. Which of the following comparisons would be most appropriate audit test for the amount
of recorded goodwill?
a. The purchase price and the book value of assets purchased.
b. The purchase price and the fair value of the asset purchased.
c. The figure for goodwill specified in the contract of purchase.
d. Earnings in excess of 5% of net assets for the past five years.

6. In verifying the amount of goodwill recorded by a client, the most convincing evidence an
auditor can obtain is by comparing the recorded value of asset acquired with
a. Assessed value as evidenced by tax bills.
b. Seller’s book value as evidenced by financial statements.
c. Insured value as evidenced by insurance policies.
d. Appraised value as evidenced by independent appraisals.
 7. A corporate balance sheet indicates that one of the corporate assets is a patent. An
auditor will most likely obtain evidence regarding the continuity validity and existence of
this patent by obtaining a written representation from
a. A patent attorney
b. The patent advisor
c. The SEC
d. The patent owner

8. In testing the existence assertion for an intangible asset, an auditor would probably rely
on:
a. Observation
b. Recomputation
c. Vouching
d. Analytical Review

9. When the auditor wants to test the asset for impairment, the auditor would most likely be
concerned with the recoverable amount of an intangible asset. For this purpose,
recoverable amount of an intangible asset is:
a. Fair value less cost to sell
b. Value in use
c. Fair value less cost to sell or value in use, whichever is lower
d. Fair value less cost to sell or value in use, whichever is higher

10. An auditor, examining intangible assets would most likely take exception to the
capitalization of the cost of:
a. Website development
b. Software development
c. Licensing a patent
d. Goodwill in a business combination

Solutions and Explanations

1. Answer: C

PAS 38 Criteria for initial recognition

2. Answer: A

Assertions about valuation and allocation deal with whether assets, liabilities, and equity
interests have been included in the financial statements at appropriate amounts. Recalculation
of the amortization and review of the amortization period would test the valuation and allocation
assertion.
3. Answer: A

The cost of an internally generated intangible asset comprises all directly attributable costs
necessary to create, produce, and prepare the asset to be capable of operating in the manner
intended by management. (PAS 38, par 66)

Research and development activities are directed to the development of knowledge. Therefore,
although these activities may result in an asset with physical substance (eg a prototype), the
physical element of the asset is secondary to its intangible component, ie the knowledge
embodied in it. (PAS 38, par 5)

4. Answer: D

The acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a)
over (b):

(a) the aggregate of: (i) the consideration transferred measured in accordance with this IFRS,
which generally requires acquisition-date fair value; (ii) the amount of any non-controlling
interest in the acquiree measured in accordance with this IFRS; and (iii) in a business
combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held
equity interest in the acquiree.

(b) the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities
assumed measured in accordance with this IFRS. (PFRS 3, par 32)

Goodwill recognised in a business combination is an asset representing the future economic

benefits arising from other assets acquired in a business combination that are not individually
identified and separately recognised. The future economic benefits may result from synergy
between the identifiable assets acquired or from assets that, individually, do not qualify for
recognition in the financial statements. (PAS 38, par 11)

5. Answer: B

The acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a)
over (b):

(a) the aggregate of: (i) the consideration transferred measured in accordance with this IFRS,
which generally requires acquisition-date fair value;(ii) the amount of any non-controlling interest
in the acquiree measured in accordance with this IFRS; and (iii) in a business combination
achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity
interest in the acquiree.

(b) the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities
assumed measured in accordance with this IFRS. (PFRS 3, par 32)
6. Answer: D

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction in the principal (or most advantageous) market at the measurement date
under current market conditions (ie an exit price) regardless of whether that price is directly
observable or estimated using another valuation technique. (PFRS 13, par 24)

7. Answer: A

Explanation:

PSA 580, paragraph 3 Written Representations as Audit Evidence

Audit evidence is all the information used by the auditor in arriving at the conclusions on which
the audit opinion is based. Written representations are necessary information that the auditor
requires in connection with the audit of the entity’s financial statements. Accordingly, similar to
responses to inquiries, written representations are audit evidence.

PSA 580, paragraph A4 to A7 Management from whom Written Representations Requested

Written representations are requested from those responsible for the preparation and
presentation of the financial statements. Those individuals may vary depending on the
governance structure of the entity, and relevant law or regulation; however, management (rather
than those charged with governance) is often the responsible party. Written representations
may therefore be requested from the entity’s chief executive officer and chieffinancial officer, or
other equivalent persons in entities that do not use such titles. In some circumstances, however,
other parties, such as those charged with governance, are also responsible for the preparation
and presentation of the financial statements.

Due to its responsibility for the preparation and presentation of the financial statements, and its
responsibilities for the conduct of the entity’s business, management would be expected to have
sufficient knowledge of the process followed by the entity in preparing and presenting the
financial statements and the assertions therein on which to base the written representations.

In some cases, however, management may decide to make inquiries of others who participate
in preparing and presenting the financial statements and assertions therein, including
individuals who have specialized knowledge relating to the matters about which written
representations are requested. Such individuals may include:

• An actuary responsible for actuarially determined accounting measurements.

• Staff engineers who may have responsibility for and specialized knowledge about
environmental liability measurements.

• Internal counsel who may provide information essential to provisions for legal claims.
In some cases, management may include in the written representations qualifying language to
the effect that representations are made to the best of its knowledge and belief. It is reasonable
for the auditor to accept such wording if the auditor is satisfied that the representations are
being made by those with appropriate responsibilities and knowledge of the matters included in
the representations.

8. Answer: C

PSA 500, paragraph A14: A15 Inspection

Inspection involves examining records or documents, whether internal or external, in paper

form, electronic form, or other media, or a physical examination of an asset. Inspection of
records and documents provides audit evidence of varying degrees of reliability, depending on
their nature and source and, in the case of internal records and documents, on the effectiveness
of the controls over their production. An example of inspection used as a test of controls is
inspection of records for evidence of authorization.

Some documents represent direct audit evidence of the existence of an asset, for example, a
document constituting a financial instrument such as a stock or bond. Inspection of such
documents may not necessarily provide audit evidence about ownership or value. In addition,
inspecting an executed contract may provide audit evidence relevant to the entity’s application
of accounting policies, such as revenue recognition.

9. Answer: D

The recoverable amount of an asset or a cash-generating unit is the higher of its fair value less
costs to sell and its value in use. (PAS 36, par 6)

10. Answer: A

Website Development does not fall under the definition of Intangible Assets in PAS 38,
paragraphs 8-17, as well as under the recognition criteria in paragraphs 21-23 of the same
standard.