¶ … Roman Holiday Pizza's treatment of fair market valuation and other accounting issues, and assesses their business risk and accounting controls. Roman Holiday Pizza is a restaurant franchise that has undertaken a strategy of growth through reacquiring franchise rights. Accounting for those reacquisitions raises serious issues during the audit process.
SAS 109 states that the auditor must gain a sufficient understanding of the entity and its environment, including its internal control, so that the auditor can determine the risk of material misstatement of financial statements, either because of error or fraud. There are red flags in Roman Holiday's environment.
According to the audit team, Roman Holiday has been growing faster than other firms within the industry, but analysts expect that growth rate to slow. Annual sales growth for firms in the restaurant industry was 4.3% for the preceding year, 2006. During recent years, most of Roman Holiday's growth came from acquisitions of franchise rights and existing restaurants, rather than real growth in the franchise. Consequently management is under some pressure to meet growth targets and earnings forecasts.
Also, the preparation of Roman Holiday's financial statements indicate they did not follow GAAP with respect to the valuation of franchise rights, nor is it clear that impairment testing is adequate. These questionable accounting practices raise the possibility that Roman Holiday's assets and income are materially misstated.
Business Risk Assessment
The process of risk assessment is used to identify and analyze risks to the achievement of an entity's objectives, in order to determine how those risks should be managed. Roman Holiday's treatment of reacquisition rights, their valuation approach and impairment testing pose significant risks to them achieving their business objectives. Roman Holiday accounted for the value of reacquired franchise rights by treating them like goodwill; they determined the excess of the net amount assigned to identifiable assets and liabilities. This valuation method is incorrect and according to PCAOB 2007a, paragraph 28, the auditor has a duty to identify any financial...
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