Two months prior to the end of calendar year 1967, AEI Ltd. forecast a year end profit of (10.0 million. During those final two months of 1967, AEI Ltd. was acquired by GEC Ltd. GEC Ltd. subsequently reported that AEI Ltd. incurred a net loss of (4.5 million for calendar year 1967. A joint statement by the auditors of the two firms attributed (5.0 million of the (14.5 million reporting difference to adverse operational factors that were substantially supported by fact. The remaining (9.5 million of the reporting difference was held by the auditors in the joint statement to reflect adjustments that were made on the basis of judgement as opposed to matters of fact. The objective of this case analysis is to reflect on the issues that might have been involved in judgemental adjustments that recast downward AEI Ltd. operating performance by (9.5 million.
Three issues that are quite likely to have been involved in the (9.5 million downward adjustments of the profit of AEI Ltd. by GEC Ltd. are accounting for intangible assets, accounting for research and development expenditures, and financial disclosure practices. The ways in which each of these three issues could have contributed to the (9.5 million in adjustments, together with the motivations for the actions and behaviors of the parties involved, are discussed in the remainder of this case analysis.
Costs assigned to intangible assets are not supposed to reflect any costs of developing, maintaining, or restoring such intangibles subsequent to their acquisition by a firm. Further, costs assigned to identifiable intangibles may not be merged with or replaced by amounts relating to other identifiable intangibles or goodwill. With respect to assets acquired from other firms, intangible assets that can be separately identified at the time of acquisition should be assigned a portion of the total cost of the acquired enterprise if the fair values of those assets can be reliably det...