There are, however, two conditions Auto World must meet before accounting for Pit Stop as a separate component and these are the conditions on whether Pit Stop shall be reported as a “ discontinued operations” (SFAS No. 144, Par. 42) or not. These two conditions, according to Par. 42 of SFAS No. 144, are that Pit Stop’ s operations and cash flows will be significantly eliminated after the sale and that Auto World will have no significant influence on Pit Stop’ s future operations. The second condition was already met based on the declaration of Auto World that the royalty agreement does not give Auto World significant influence over the operations of Pit Stop.
As to the first condition on the elimination of operations and cash flows, we use here as a basis the contents of EITF Issue No. 3 – 13. According to EITF Issue No. 3 – 13, if the cash flows will be considered direct and significant to the total operations of Auto World as per its definition, the sold operations will not be considered a discontinued one. In Auto World’ s case, the royalty fees that it will receive after the disposition of Pit Stop are not direct cash flows as these are not the same as those generated by Pit Stop prior to its disposal.
Thus, Pit Stop’ s disposal may be properly accounted for as discontinued operations. For auditing procedures and the related audit evidence, the first set of audit procedures will be geared towards determining if Pit Stop is really a component of an entity. For this one, we have to obtain an understanding of the exact business purpose of Pit Stop as a component of Auto World and how Pit Stop relates to the rest of the operations of Auto World.
This can be done through the following: (1) inquire from management the business purpose of Pit Stop, how Pit Stop relates to the rest of the operations of Auto World and how management analyzes the operations and financial results of Pit Stop.
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