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Summary of Reacquired Franchise Rights

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  • Pages: 4
  • Word count: 989
  • Category: Company

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It has come to our attention that much of Roman Holiday’s recent revenue growth came from acquisition of franchise right and existing restaurants rather than real growth in the franchise. Management is aware of these issues and may be feeling some pressure to meet growth targets and earnings forecasts. In the following working papers, we address this potential issue by reviewing the various accounting treatments for the reacquired franchise rights. We also examine the reacquired franchise rights from the Arizona acquisition and assess the reasonableness of management’s assumptions in its impairment analysis. Q1

Purpose: The purpose of this testing procedure is to verify the mathematical accuracy of the schedule and reconcile the total to the preliminary balance sheet to ensure the assertions of accuracy and valuation are met.

Audit Procedure:
1. Obtain the client prepared schedule of reacquired franchise rights during the year. 2. Trace and agree all amounts to last year working paper. 3. Trace and agree book value of reacquired franchise rights to respective impairment analysis schedule to ensure no impairment losses. 4. Recalculate the balance at end of the year to verify that the correct amount is calculated. 5. If the balance at end of the year is not correctly calculated, reconcile the total balance at end of the year to the reacquired franchise right amount on the preliminary balance sheet. Working paper see appendix 1.

There is a 2000 difference between the recalculated balance at end of the year 127,414,000 and the client recorded balance of 127,412,000. The difference is way below the materiality which is 5 million, therefore the difference is immaterial. Based on the audit procedures performed, the schedule of reacquired franchise rights is mathematically accurate. Q2

Purpose: to evaluate the appropriateness of the client’s determination of an indefinite life classification for the reacquired franchise rights, and whether it is consistent with SFAS142. Analysis:

In the past few years, Roman Holiday was reacquiring rights for existing restaurants and/ or undeveloped markets. The reasons for these acquisitions are varied and include taking over poorly performing restaurants to protect the company’s brand name and to preserver the value of the local market. Reacquisitions also take place for strategic cash flow management purposes whereby investing current free cash flows in the reacquisition yields the expectation of replacing franchise royalties with the larger profits from the restaurants themselves. Company almost always pays some premium related to the contractual element of the franchise right that is capitalized as an intangible asset. However, it must be noted that the classification and nature of the intangible asset varies substantially. Roman Holiday defined reacquired franchise rights as “the excess of the net amount assigned to identifiable assets and liabilities recorded upon the acquisition of franchise markets.” It was classified as an intangible asset with an indefinite life.

The reacquired franchise rights takes over 29% of Roman Holiday’s total asset and the complicities in the classifications introduce significant risks of material misstatement in the company’s financial statements. The classification should be critically assessed in order to ensure the fair presentation of the company’s financial statement. Based on SFAS No.142 states goodwill and intangible assets that have indefinite useful life will not be amortized but rather will be tested at least annually for impairment. And the intangible assets that have definite useful life should be amortized. The classification and the nature of intangible assets vary significantly in the quick-service restaurant industry and often depend on the company.

We will base our analysis by SFAS No.142. Criteria of SFAS No. 142 to determine the useful life of the intangible asset is quoted in the appendix 2. There is no expected use of the reacquired franchise rights; for competitive, even though Roman holiday only occupied less than 5% of the US market; it targets specific customers who are willing to pay premiums. For Roman holiday, it is trying to create a niche. The competitiveness is less than the companies whose strategy is cost leader. And after the financial crisis of 2009, as for 2012, the market is warming up, the defect of the crisis is fading away, the demand will not be affected. So there is no legal, regulatory, contractual provision competitive, economic, or other factors limit the useful life that may limit the useful life. Conclusion:

Since there is no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of reacquired franchise rights, the classification of indefinite useful life is appropriate.

The useful life of an intangible asset to an entity is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity. The estimate of the useful life of an intangible asset to an entity shall be based on an analysis of all pertinent factors: 1. The expected use of the asset by the entity

2. The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate (such as mineral rights to depleting assets) 3. Any legal, regulatory, or contractual provisions that may limit the useful life 4. Any legal, regulatory, or contractual provisions that enable renewal or extension of the asset’s legal or contractual life without substantial cost (provided there is evidence to support renewal or extension and renewal or extension can be accomplished without material modifications of the existing terms and conditions) 5. The effects of obsolescence, demand, competition, and other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels) 6. The level of maintenance expenditures required to obtain the expected future cash flows from the asset (for example, a material level of required maintenance in relation to the carrying amount of the asset may suggest a very limited useful life).

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