Trueblood Case

SUBJECT: Deciding the Appropriate Extent of Audit Performed for Billy’s Beats for Asset Valuation Billy’s Beats Inc. , an SEC registrant, is a new audit client with a fiscal year-end of December 31, 2010. Billy’s is a manufacturer of musical instruments. Billy’s acquired Little Drummer Boy Inc. in 2010 for $575 million in cash. Significant assets acquired included property, plant, and equipment totaling $865 million and other assets totaling $145 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 Billy’s are 20 years and 10 years. Other included assets of acquired customer lists, were assigned a useful life of 15 years. 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 the assets which Billy’s had already owned. Management stated that the useful lives for the acquired assets were the amounts used by Little Drummer before the acquisition.

The engagement team discussed the useful lives of the acquired property, plant, and equipment with the plant manager of Little Drummer. 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. This discussion was documented in the audit working papers. The valuation specialist allocated the plant fair value of $865 million to each asset class based on the percentage of the seller’s total original cost applicable to each asset class. These percentages were provided by management of Little Drummer and relied on by the valuation specialist.

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, no further testing of the client-prepared spreadsheet was performed by the engagement team. In addition to its drum manufacturing business, Billy’s also wholly owns RockOut Inc. , which is the largest manufacturer of guitars in the United States. RockOut grew through the acquisition of other guitar companies and completed five acquisitions durng 2012, eight acquisitions during 2009, and four acquisitions during 2008.

As a result of the acquisitions, RockOut reported approximately $90 million, which was 15 percent of total assets and 60 percent of total intangible assets, of customer lists as of December 31, 2010. RockOut amortizes its customer lists on a straight-line basis over 25 years, which management believes reflects the pattern in which the economic benefits of the customer lists are used up. During 2010, management revised its estimate of the customer list economic life, and began assigning an amortization period of 15 years to newly acquired national customer lists.

Amortization expense for the year ended December 31, 2010, 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 national customer lists lives.

According to IAS 16, The cost of an item of property, plant and equipment comprises, its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates, any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management, and the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. Because this in not how the company decided on the value and useful lives of the assets in question they should have follows IAS 36 to determine if there was an impairment. The audit procedures for determining if there was a valuation problem could also be addressed using FASB Statement No. 142.