Case 1: Blouins Beatz Inc.

Blouins Beatz Inc. (Blouins), an SEC registrant, is a new audit client of your firm with a fiscal year-end of December 31, 2019. Blouins manufactures headphones.

Blouins acquired Lil Phonz Inc. (Lil Phonz) in 2019 for $575 million in cash. The fair value of significant assets acquired was determined by an external valuation specialist and included property, plant, and equipment totaling $865 million (based on an appraisal of the market prices of similar assets) 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 Blouins are 20 years and 10 years, respectively. Acquired customer lists, included in other assets, 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 that which Blouins had already owned. Management stated that the useful lives for the acquired assets were the amounts used by Lil Phonz before the acquisition. The engagement team discussed the useful lives of the acquired property, plant, and equipment with the plant manager of Lil Phonz. 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 sellers total original cost applicable to each asset class. These percentages were provided by management of Lil Phonz 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, Blouins also wholly owns RockIt Inc. (RockIt), which is the largest manufacturer of guitars in the United States.

RockIt grew through the acquisition of other guitar companies and completed five, eight, and four acquisitions during 2019, 2018, and 2013, respectively. As a result of the acquisitions, RockIt reported approximately $90 million (15 percent of total assets and 60 percent of total intangible assets) of customer lists as of December 31, 2019. RockIt 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 2019, management revised its estimate of the customer list economic life, and began assigning an amortization period of 15 years to newly acquired customer lists. Amortization expense for the year ended December 31, 2019, 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 managements 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.

Blouins Beatz Requirements:

1. Did the engagement team perform adequate and appropriate audit procedures considering managements assumptions? (Note that your focus should be on the substantive audit procedures performed, not the accounting treatment nor the control testing.)
   1. For Lil Phonz?

1. 2. For RockIt?
2. If the engagement team did not perform adequate and appropriate procedures, describe what additional procedures you would have performed. Be specific including what information, if any, you would request from management.
   1. For Lil Phonz?
   2. For RockIt?
3. How would the engagement teams assessment of internal controls impact their decisions about testing managements assumption?