Question

Mobile Security, Inc. (MSI) has been an audit client of Leo & Lee, LLP for the past 12 years. MSI is a small, publicly traded aviation company based in Cleveland, Ohio, where it manufactures high-tech unmanned aerial vehicles (UAV), also known as drones, and other surveillance and security equipment. MSI’s products are primarily used by the military and scientific research institutions, but there is growing demand for UAVs for commercial and recreational use. MSI must go through an extensive bidding process for large government contracts. Because of the sensitive nature of government contracts and military product designs, both the facilities and records of MSI must be highly secured.

MSI is known as being an innovator in the industry and holds 25 patents on its products. One of its older patents is for the Covert Recorder, a listening device for land-line phones. Sales of the Covert Recorder have slowly declined in the last decade, primarily due to increased use of smart phones and other advances in technology. For the last few years, management has debated whether the patent, which currently has a carrying value of $500,000, should be impaired. Management conducted an analysis by estimating the future cash flows that will be generated from sales of the Covert Recorder. Based on the analysis, management believes an impairment loss of $400,000 should be recorded and the patent balance written down for the current year.

A. Information gathering: Prepare a list of questions that the auditors would ask MSI managers regarding how the impairment loss was determined.

B. Analysis and evaluation: Comment on the level of estimation uncertainty that is involved with determining if the patent is impaired. What factors in this case affect estimation uncertainty?

C. Analysis and evaluation: Explain the role of management bias in situations such as the impairment issue with the patent.

D. Analysis and evaluation: What substantive audit procedures should be performed for the audit of the Covert Recorder patent balance?

Answer 1

Ans A: Auditor of MSI shall ask following question

1. whether the future value of the asset's undiscounted cash flows is less than the book value of the asset.
2. What are the basis of assumption for estimating future cash flows.
3. Why management thinks that remaining carrying value of Patent would be recovered through continuing use.

Ans B: Factors affect estimation uncertainity: In this case, uncertainity is very high because it is an Intangible Assets measurment of which is very subjective, also Patent is having almost no shelf life.

1. Correctness in measurement of Future cash flows
2. Life of patent
3. MAnagement assumption

Ans C: Management biasness may be high in case of impairment becasue it reduces performance of orgnaisation.

Due to impairment of Patent to the tune of $400,000 would reduce book profit of entity. That is why management here would try to resist making impairment of patent.

Ans D:Audit shall perform Test of detail of transaction , Test of Account balance and then Analytical Procedure.

Audit shall obtain evidence of subsequent period to Financial Statement date to obtain whether any cashflow expected from Patent are realising, whether covert recorder product is being sold by Entity.