Auditing Special Purpose Frameworks: Auditing Investments

It is necessary for the auditors to identify the financial reporting framework adopted by the entity, while performing audit of investments. Generally Accepted Accounting Principles provide guidance regarding audit of investments. Some of the common areas are described as below:

Intangible Assets

Intangibles with definite useful lives are amortized over their useful lives and old intangible assets are tested for impairment if some indications, either internal or external, are shown. Whereas intangible assets having indefinite useful lives are only impairment tested annually. For SMEs, instead of impairment\test, all intangibles are required to be amortized over their useful lives.

Financial Assets/Liabilities – Investment Differences

Financial assets and liabilities are accounted for either at amortized cost, which are held for non-trading purposes, or at fair value, being invested for trading purposes. For SMEs, these investments are recorded on historical cost, while trading-focused investments are recorded on market value.

Derivative Differences

Derivatives are recorded at fair value, like assets and liabilities. Hedge accounting is also allowed for entities other than SMEs. SMEs are required to disclose derivatives, on cash settlement basis. These disclosures include principal amount of derivative, its nature, terms and risks, purpose for which derivatives are purchased and net settlement amount of derivative at the reporting date.

Business Combinations

An entity having an investment in 50% shares of another entity, then it becomes subsidiary and is needed to be consolidated with the parent (who purchased 50% shares). In case of bankruptcy or so, subsidiary could not be consolidated because of losing the control over that entity. Same is the guidance for SMEs, with one exception to use cost method to record investment in case of control lost.

To record the subsidiaries, fair values of acquisitions, assets, liabilities, and non-controlling interest are needed to calculate the value of subsidiary at the reporting date. For SMEs, it is compulsory to use market values at the time of acquisition, and they are also required to provide disclosures just like normal entities under GAAP.

Goodwill Differences

Entities are required to test goodwill for impairment annually, not amortizing it. While SMEs may choose to amortize goodwill over either federal income tax period or 15 years. No tests of impairment are required for both tangibles and intangibles.

Fair Value Accounting

Fair value is the price that would be from sale of an asset or paid to transfer a liability in an arm’s length transaction. Whereas SMEs are required to use market value only in case of non-monetary transactions, debt securities held for sale and business combinations.