Auditing & Assurance Services 6th Edition by Timothy Louwers

Exercise 40

Related-Party Transaction "Goodwill." Write the audit approach section like the cases in the chapter.
Hide the Loss under the Goodwill
Gulwest Industries, a public company, decided to discontinue its unprofitable line of business of manufacturing sporting ammunition. Gulwest had capitalized the startup cost of the business, and with its discontinuance, the $7 million deferred cost should have been written off. Instead. Gulwest formed a new corporation, Amron. and transferred the sporting ammunition assets (including the $7 million deferred cost) to it in exchange for all Amron stock. In the Gulwest accounts, the Amron investment was carried at $12.4 million, which was the book value of the assets transferred (including the $7 million deferred cost).
Gulwest and a different public company (Big Industrial) created another company (BigShot Ammunition). Gulwest transferred all Amron assets to BigShot in exchange for (1) common and preferred stock of Big Industrial valued at $2 million and (2) a note from BigShot in the amount of $3.4 million. Big Industrial thus acquired 100 percent of the stock of BigShot. Gulwest management reasoned that it had "given" Amron stock valued at $12.4 million to receive stock and notes valued at $5.4 million, so the difference must be goodwill. Thus, the Gulwest accounts carried amounts for Big Industrial Stock ($2 million), BigShot's note receivable ($3.4 million), and Goodwill ($7 million).
Gulwest directors included in the minutes of board meetings an analysis of the sporting ammunition business's lack of profitability. The minutes showed approval of a plan to dispose of the business, but they did not use the words discontinue the business. The minutes also showed approval of the creation of Amron, the deal with Big Industrial, the formation of BigShot. and the acceptance of Big's stock and BigShot's note in connection with the final exchange and merger.