Auditing a business combination: AU-C 540, 620 and 600

• Assess the risks in a purchase price allocation under AU-C 540
• Evaluate the work of an auditor’s specialist under AU-C 620 and a management’s specialist under AU-C 501
• Plan component work and component performance materiality under AU-C 600 as revised by SAS 149
• Evaluate a difference between management’s estimate and the auditor’s range

Where the risk sits

A material acquisition touches almost every assertion. The purchase price allocation is a set of accounting estimates with high estimation uncertainty, the consideration may include contingent consideration and equity, the acquiree brings its own controls and systems, and the consolidated statements now include a new component. Many teams assess the valuation of acquired intangible assets and contingent consideration as a significant risk.

AU-C 540: the estimates

AU-C 540, as revised by SAS 143, applies the separate assessment of inherent risk and control risk required by AU-C 315 to each estimate, considering estimation uncertainty, complexity and subjectivity. The auditor responds with one or more of:

• obtaining evidence from events occurring up to the date of the auditor's report (for example, a working capital true-up that settles, or actual post-closing customer revenue)
• testing how management made the estimate: the method, the significant assumptions and the data
• developing an auditor's point estimate or range

For a customer relationship valued with the multi-period excess earnings method, the significant assumptions are usually revenue from existing customers, the attrition rate, margins, contributory asset charges and the discount rate. Compare attrition with the acquiree's historical customer data, margins with the deal model and the acquiree's history, and the discount rate with the internal rate of return implied by the price and the weighted average cost of capital. A rate set too low inflates the intangible; a forecast more optimistic than the deal model is a bias indicator.

When the auditor's range does not include management's point estimate, the misstatement is the difference between management's point estimate and the nearest point of the auditor's range. The auditor also evaluates indicators of possible management bias across all the estimates together.

Specialists

Most acquirers use a management's specialist to value the assets. AU-C 501 requires the auditor, to the extent necessary, to evaluate that specialist's competence, capabilities and objectivity, obtain an understanding of the work, and evaluate the work's appropriateness as audit evidence.

When the engagement team needs valuation expertise of its own, it uses an auditor's specialist under AU-C 620. The auditor evaluates the specialist's competence, capabilities and objectivity, obtains an understanding of the specialist's field, agrees on the nature, scope and objectives of the work, roles and communications, in writing when appropriate, and evaluates the adequacy of the work: the relevance and reasonableness of the findings, the significant assumptions and methods, and the relevance, completeness and accuracy of significant source data. The auditor does not refer to the specialist in an unmodified report.

AU-C 600: the group

AU-C 600 as revised by SAS 149 is effective for audits of group financial statements for periods ending on or after December 15, 2026. Key points for an acquisition:

• The group auditor takes responsibility for identifying and assessing risks of material misstatement of the group statements, including the consolidation process, and decides the components at which work will be performed.
• For components where work is performed, the group auditor sets component performance materiality lower than group performance materiality to address aggregation risk, and a threshold for communicating misstatements that does not exceed the amount regarded as clearly trivial to the group statements.
• Component auditors are part of the engagement team. The group engagement partner must be sufficiently and appropriately involved in their work and maintain two-way communication.
• The group auditor may instead make reference to the audit of a referred-to auditor when the conditions in AU-C 600 are met, and the report then states that.
• Equity method investees can be components.

Other procedures

• Read the purchase agreement, disclosure schedules and funds flow memo; agree consideration to cash disbursed and shares issued.
• Test the acquisition date, the identification of the acquirer, and the business versus asset conclusion.
• Test opening balances of the acquiree at the acquisition date, not only at year end.
• Test the separation of compensation, settlement of preexisting relationships and acquisition costs from consideration.
• Review the measurement-period and contingent consideration accounting after closing.
• Evaluate the ASC 805 disclosures and obtain specific written representations on the significant assumptions under AU-C 580.

The AU-C 600 page and the AU-C 540 page summarize the requirements.

Testing a customer relationship and setting component materiality