Sweet Sound Inc. Audit Case Study

Advanced Auditing Case Exam 3        

Student’s name:                                                        Date:

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Sweet Sound Inc. Audit Case

Sweet Sound Inc. (Sweet), an SEC registrant, is a new audit client with a fiscal year-end of December 31, 2017. Sweet manufactures musical instruments.

Sweet acquired 100% of Pure Piano Inc. (Pure Piano) in 2017 for $705 million in cash. An external valuation specialist determined the fair value of the acquired assets, which included property, plant, and equipment totaling $850 million (based on an appraisal of the market prices of similar assets) and other assets totaling $140 million. The useful lives assigned to the property, plant, and equipment acquired were 30 years for the plant and 15 years for the equipment. The useful lives for the plant and equipment already owned by Sweet are 20 years and 10 years, respectively. A useful life of 15 years was assigned to acquired customer lists, which was one of the other assets obtained.

To test the useful lives of the operating assets, the engagement team asked management why the number of years assigned to the plant and equipment acquired differed from the years assigned to that which Sweet had already owned. Management stated that the useful lives for the acquired assets were the amounts used by Pure Piano before the acquisition. The engagement team discussed the useful lives of the acquired property, plant, and equipment with the plant manager of Pure Piano. The plant manager stated that 30 years and 15 years for the plant and the equipment, respectively, were the useful lives used before the acquisition. The audit team documented the discussion with the client’s management regarding useful lives in the audit working papers.

The valuation specialist allocated the plant fair value of $850 million to each asset class based on the percentage of the seller’s total original cost applicable to each asset class. Pure Piano’s management provided those percentages were provided to the valuation specialist, who relied upon them. The engagement team compared the percentage of total costs to a client prepared spreadsheet listing each asset class, asset ID, and percentage of total cost. No errors were noted and, accordingly the audit engagement team performed no further testing of the client-prepared spreadsheet.

In addition to its piano manufacturing business, Sweet also wholly owns Tupelo Inc. (Tupelo), which is the largest manufacturer of acoustic guitars in the United States.

Tupelo grew through the purchase of other acoustic guitar companies and completed five, eight, and four acquisitions during 2015, 2016, and 2017, respectively. The acquisitions resulted in Tupelo reported approximately $90 million (15 percent of total assets and 60 percent of total intangible assets) of customer lists as of December 31, 2017. Tupelo amortizes its customer lists on a straight-line basis over 25 years, which management believes reflects how the customer lists provide economic benefits to Tupelo.

During 2017, Tupelo’s management revised its estimate of the economic life of the recently acquired customer lists (the ones from purchasing other guitar companies in 2015, 2016, and 2017) to an amortization period of 15 years. All customer lists that Tupelo obtained prior to 2015 continued to be amortized using a 25-year life.

Tupelo’s amortization expense for the year ended December 31, 2017, was $3 million.

To test the economic lives of the customer lists, the engagement team asked management what the reasoning was for the change in the assumed economic life this year. Management provided a memorandum that discussed the rationale for using the 25-year economic life to amortize the various customer lists, as well as the rationale for the current-year change in management’s estimate of the newly acquired customer lists lives. This memo was included in the audit working papers, but the working papers did not include any additional documentation from the engagement team.

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The following pages provide:

Overall instructions that apply to all questions        Page 3        

Beginning level, foundational questions                Page 3        

Application questions                                        Page 4

Grading of answers                                        Page 5

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Overall instructions that apply to all questions:

1. In creating your answers, you should do as little “copying and pasting” from the case situation description and/or auditing standards as possible. The first reason is because I edited this case myself and I can easily read the text in the auditing standards. The much more important second reason is that I want to see your ability to apply your knowledge and skills to the case situation by developing realistic and logical answers.

1. Single-space your answers. Use 12-point Times Roman font and 1” margins all around.

1. Present your answers in a neat, easy to follow format. That includes but is not limited to:

1. provide the question before your answer,
2. double-space between each answer,
3. indent any bullet points or numbered lists included in your answer, and
4. if you have only a couple of lines left at the bottom of a page to start the next question then insert a page break and put it on the next page.

1. This is in individual assignment. Do not interact with any other person in working on this case. Use the provided text of auditing standards and not any other auditing standards (for example, do not refer to any parts of AS 2110 or any other audit standard not provided to you along with this case). Do not use any resources other than the case description, the provided text of auditing standards, authorized Advanced Auditing course resources (such as the Wiley CPA Excel study guide and videos), the auditing text you had for ACC 553/653 (if you still have it), and your own notes you took during class sessions in ACC 750. One example that is not an allowed resource (obviously not a complete list) is accessing any website other than the Wiley CPA Excel site for ACC 750.

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Beginning level, foundational questions.

1. Based on the case situation description, which assertion(s) and for which exact item(s), if any, for Pure Piano, Inc. have a relatively high risk of material misstatement? Regardless of whether you answer “none”, or list many, or are somewhere in-between, provide clear, well-explained, well-organized reasons to support your conclusion.

1. Based on the case situation description, which assertion(s) and for which exact item(s), if any, for Tupelo, Inc. have a relatively high risk of material misstatement? Regardless of whether you answer “none”, or list many, or are somewhere in-between, provide clear, well-explained, well-organized reasons to support your conclusion.

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Application questions.

Specific instruction for questions 3 and 4:

In your answers, do not discuss or address the auditor’s testing of controls.

Focus on planning activities, risk assessment, substantive audit procedures performed, and anything else you consider relevant (as long as it does not relate to testing controls).

Answer the following based on your understanding of auditing concepts (what you have learned in this course and your first auditing course), and on whichever portions of the provided selected sections of auditing standards you consider relevant to the questions asked below.