Reid Co. has a significant investment in Red Oak Ltd., carried on the books at cost. The investment is \($45\) million, but Red Oak Ltd. has fallen on hard times. The current trading price of the stock shows that the market value of Reid’s investment is only about \($28\) million. On the other hand, Red Oak’s management has addressed the problems. Further, the stock price dip has been made worse by a recession that appears to be ending soon.

Thus, it appears that Red Oak will become profitable again, and the long-term outlook for a return to above-average profitability is very good. Reid has indicated that it intends to maintain its investment in Red Oak for the long term, even though Red Oak has currently suspended dividend payments.

Required:

a. What evidence should the auditor evaluate to determine whether the investment in Red Oak should be written down to current market value?

b. Assume that Reid did write down its investment to \($28\) million and, one year later, its value rose to \($35\) million. The company wants to write the investment up to \($35\) million.

What audit evidence would be needed to support such an increase in value?