CHAPTER 12

The audit of non-current assets

EXAM FOCUS
The audit of non-current assets m ust be approached in a structured orderly way. Questions on
this area are a source of easy marks for the well-prepared student. The audit of non-current
DVVHWVWHVWVWKHVWXGHQW·VNQRZOHGJHLQYDULRXVZD\V$JRRGVWXGHQWVKRXOGEHIDPLOLDUZLWK
the internal controls over tangible non-current assets. It is useful here to focus on the financial
statement assertions that underlie the reporting of non-current assets in the financial
statements. The audit of tangible non-current assets inevitably raises the issue of depreciation
and the requirements of IAS 16. A detailed know ledge will not be required here but you
should demonstrate an understanding of the principles of good practice.

This w ill enable recall of the necessary audit w ork to verify the expenditure, ow nership and
title.

Finally know ledge of the disclosure requirements for non-current assets is essential. A good
student should be familiar with the format of the balance sheet illustrated in IAS 1 and the way
in w hich non-current asset m ovements are reported in the notes to the financial statements.

SYLLABUS AND STUDY GUIDE COVERAGE

This chapter covers the following elements of the ACCA study guide:

12 Internal Control III - Revenue Expenditure and Capital Expenditure

¨ Describe, illustrate and analyse how internal control systems over revenue and
capital expenditure transaction cycles operate in both large and small entities.

¨ Describe and illustrate the use by auditors of internal control checklists for revenue
and capital expenditure transaction cycles.

¨ Describe and tabulate tests of control of revenue and capital expenditure for
inclusion in a w ork program.

¨ Explain and illustrate how structural and operational weaknesses in revenue and
capital expenditure systems should be reported to management and how
recommendations should be made.

  2WKHU $XGLW DQG 5HYLHZ (YLGHQFH 9, ² 7DQJLEOH 1RQ&XUUHQW $VVHWV DQG /RQJ7HUP
Liabilities

¨ Describe and tabulate for inclusion in a w ork program the substantive procedures
used in obtaining evidence in relation to tangible non-current assets and non-
current liabilities, and the related income statement entries.

¨ Explain the purpose of substantive procedures in relation to financial statement

assertions concerning tangible non-current assets and non-current liabilities.

In order to cover these elements the follow ing topics are included:

Verification of tangible non-current assets

175
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH ,QWHUQDWLRQDO

Verification of intangible non-current assets (goodwill, patents and R&D expenditure)

Verification of non-current asset investments

1 General considerations affecting all non-current

assets
1.1 Introduction
The auditor has a duty to form an opinion on w hether the financial statements agree with the
underlying records and give a true and fair view. This duty can only be discharged if the
auditor is satisfied with the quality of evidence obtained, and if the evidence-gathering
procedures meet the necessary standard of skill and care. This, of course, is highly subjective
and the prudent auditor should consider a number of factors w hen determining the correct
audit approach to the task of verifying assets.

+HUHDUHVRPHRIWKHIDFWRUVWKDWLQIOXHQFHWKHDXGLWRU·VDSSURDFK

Reliability, or otherwise, of the system s of accounting and internal control

¨ The reliability of system s of accounting and internal control will obviously influence the
manner in w hich the auditor seeks reassurance. If the auditor is dealing with an
undertaking w here there is a high volume of transactions, and the balance sheet contains
items of high m onetary value, he can usually do little m ore than check a token num ber of
items. This w ill only be acceptable as evidence if internal controls can be relied upon. If
internal controls are not to be relied upon, the auditor places greater emphasis on
substantive tests in order to confirm w hether or not the financial statements have been
fairly presented.

Materiality of the amounts involved

¨ A general assumption made in the evidence-gathering process is that the costs of audit
validation are matched or exceeded by the benefits obtained. Obviously, therefore, the
auditor must consider the materiality of the am ounts involved and the costs and effort
expended in the verification of the items concerned.

Current professional practice

¨ $V VWDWHG HDUOLHU WKH DXGLWRU·V DGKHUHQFH WR DFFHSWHG SURIHVVLRQDO SUDFWLFH LV D
demonstration of reasonable skill and care. IAASB pronouncements on audit practice are
clearly a codification of best practice.

Legal decisions

¨ Case law has influenced the development of audit procedures in practice. Reference will be
made to leading cases as appropriate.

The absence of suspicious circum stances

¨ W e have already discussed the assumption that is implicit in auditing, namely that while
the auditor has no general responsibility for the detection of error and fraud, his
procedures should be designed so that there is a reasonable chance of detecting material
error and fraud should it exist.

¨ It is also generally accepted that an auditor should have the ability to detect a material
misstatement in the financial statements.

176
 Chapter 12 The audit of non-current assets

1.2 Audit objectives and financial statement assertions

The audit objectives associated with the verification of assets can be sum marised as follows.

Ownership

¨ The title to the assets is clearly vested in the enterprise w hich enjoys the rights and
privileges of ow nership.

Existence

¨ The assets exist at the date of the balance sheet, and reliable evidence is available to attest
to their existence.

Valuation

¨ The assets are stated at a value which is consistent with the assumptions and conventions
adopted for preparing the financial statements. The valuation is objective (ie, the basis can
be confirmed by evidence) and consistent w ith the principles of true and fair presentation.

Presentation

¨ The assets are presented in accordance with best practice and with due regard for the legal
requirements in force at the time.

2 The audit of tangible non-current assets

2.1 Classifying tangible non-current assets
Under the heading of tangible non-current assets we can distinguish the following categories.

¨ Leasehold land and buildings.

¨ Freehold land and buildings.
¨ Plant and machinery.
¨ Other assets (motor vehicles, aircraft, fixtures and fittings etc).

2.2 Internal controls

It is useful to consider the internal controls over non-current assets, as a knowledge of these
will help the auditor in his various procedural tests in order to satisfy himself about ownership
and existence of assets held.

Controls should exist over the recording of non-current assets, the authorisation of capital
expenditure, the custody of the assets, and general managerial supervision.

Controls over recording should be based around an asset register, w hich provides details as
follows.

¨ Serial number of each non-current asset owned.

¨ 'HVFULSWLRQDQGPDQXIDFWXUHU·VQDPH
¨ Gross cost or valuation.
¨ Depreciation charged annually.
¨ Accumulated depreciation to date.
¨ Net book value.
¨ Location of the asset.

Controls over authorisation are particularly important in view of the large costs associated with
non-current assets. Their acquisition will involve the enterprise in significant amounts of
expenditure, and these should be suitably authorised by:

177
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH ,QWHUQDWLRQDO

¨ capital budgets.
¨ GLUHFWRUV·P LQXWHV
¨ capital expenditure proposals.

Controls over the custody of assets are also vital. The non-current assets of the company should
not be susceptible to m isuse and should be protected from the risk of loss by theft, premature
obsolescence or destruction. Custodial controls (as appropriate to the type of asset) include the
following.

¨ Physical controls over access to and use of the assets.

¨ $GHTXDWHLQVXUDQFHDQGVDIHFXVWRG\IRU¶SRUWDEOH·DVVHWV HJSK\VLFDOLQYHVWPHQWVP RWRU

cars, notebook computers, furniture and fittings).

¨ Adequate insurance cover to provide against the risk of destruction.

Managerial supervision is evidenced by the following.

¨ A suitable capitalisation policy, properly formulated and documented.

¨ Budgetary control to m onitor capital expenditure.

2.3 Freehold land and buildings

Verification procedures should cover both ownership and existence, and valuation.

Ownership and existence

9HULILFDWLRQ RI WKH FOLHQW·V WLWOH WR WKH DVVHW ZRXOG EH FRQILUPHG E\ LQVSHFWLRQ RI WKH ODQG
registry certificate and confirmation that the asset is free of any charge (ie, it has not been
offered as security to a lender).

Verification of existence can be achieved by vouching the payments in relation to property up-
keep such as repairs to prem ises, relevant taxes paid (eg, general and water rates), insurance
etc.

Inspection of a property register maintained by the client is further proof of existence.

Physical inspection by the auditor is strongly advised.

Valuation

The historical cost of land and buildings generally includes the cost of the asset plus the
incidental costs of purchase such as legal fees on the conveyance of title. The cost of
acquisitions can be substantiated from the completion statement prepared by solicitors acting
for the client showing the analysis of the purchase m onies.

If the building has been revalued during the period under review, the auditor m ust satisfy
him self that the valuation is objective and properly incorporated in the records by being
reflected in the revaluation reserve.

W here revaluations are carried out, good practice requires the auditor to:

¨ enquire into the basis of valuation to ensure that it is acceptable.

¨ com municate with the professional valuers, inspect their w orking papers and read their
report, in order to establish that the basis and method of valuation is objective.

178
 Chapter 12 The audit of non-current assets

2.4 Leasehold land and buildings

The document of title for the asset will be the lease. This must be read and all relevant
conditions noted. The auditor should ensure that fire insurance prem ium s, ground rents and
similar dues are paid up to the relevant dates.

2.5 Plant, m achinery, motor vehicles, aircraft

Evidence of title

The title to a motor car can be evidenced by inspection of the registration document. (This is
not conclusive evidence, because strictly speaking the registration document is not a document
of title.) Similar documentation will exist for aircraft where the government Aviation Authority
will require a Certificate of Airworthiness. The evidence of title for plant and machinery can be
validated by evidence of a cash purchase, or by the satisfactory completion of a hire purchase
agreement.

Evidence of existence

Existence may be evidenced by:

¨ physical inspection.
¨ examination of the asset register.
¨ examination of insurance policies to confirm that all risks have been insured against.

Evidence of value and presentation in the accounts

This can be obtained by:

¨ vouching all acquisitions and ensuring that there is compliance with the stated
capitalisation policy.

¨ vouching all disposals and verifying that cost and depreciation balances have been
appropriately reduced.

¨ reviewing depreciation policy to ensure that it is both consistent and acceptable.

¨ verifying calculations for depreciation.

¨ reviewing the presentation of gross cost, accum ulated depreciation and net book value for
compliance with relevant accounting standards (IAS 1 and IAS 16).

3 The audit of intangible non-current assets

3.1 Introduction
7KHWHUP¶LQWDQJLEOHQRQFXUUHQWDVVHWV·LVXVHGWRGHVFULEHWKHIROORZLQJ

¨ Goodwill.
¨ Patents and trade marks.
¨ Research and development expenditure.

The objective of the auditor in this connection will be to obtain reassurance on the following
points.

¨ That the policy for recognising capital expenditure is consistent and reasonable.

¨ That the expenditure is not overstated, and the item s are properly valued, classified and
presented.

179
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH ,QWHUQDWLRQDO

3.2 5HOLDQFHRQRSHQLQJ\HDU¶VILJXUHV ,6$

An auditor w ho has given an opinion on the opening balances generally relies on those
opening figures and need only test the closing balances to ensure that they are capable of
verification. If the opening figures were reported upon by another firm (as in a change of
professional appointment), the auditor m ust obtain reassurance about the opening figures from
the management or from the preceding auditor, or he may choose to test the opening balances
KLP VHOI +RZHYHU ZKHQ WKHUH LV DQ RQJRLQJ DXGLW DSSRLQWPHQW WKH DXGLWRU·V WDVNV XVXDOO\
break down into the following areas.

¨ Acquisitions and disposals: vouching these to ensure expenditure has been properly
accounted for.

¨ Verification of title of assets w here a document of title exists, as in registered patents.

¨ Validation of values: reviewing cost or valuation accounting methods, am ortisation

calculations etc.

3.3 Goodwill
Goodwill can be defined as the difference between the value of a business as a w hole and the
aggregate of the fair values of its separable net assets (ie, those identifiable separately).

Goodwill normally arises in two situations.

¨ Purchase of an unincorporated business.

¨ In group accounts, goodwill arising on consolidation ie, from the purchase of a subsidiary
company or associated company.

IAS 22 requires goodw ill arising on consolidation to be capitalised as an intangible asset and
amortised over its useful life.

3.4 Patents and trade marks

The main audit procedures are as follows.

¨ Obtain a list of patents and trade marks in existence and trace them to the asset register
and financial ledger.

¨ Vouch payments for the creation and registration of patents with correspondence with
patent agent and the Patent Office.

¨ Inspect the registered patent issued by the Patent Office and check that it is registered in
the name of the client.

¨ Verify calculations and reasonableness of amortisation (ie, over the life of the patent).

¨ Scan expense accounts in the nominal ledger to establish that no new patent expenses have
been wrongly written off to revenue.

¨ Check the accuracy of disclosure in balance sheet subheadings.

Note that renewal costs of patents and trade marks are always regarded as a revenue expense.

3.5 Research and development expenditure

W here development expenditure is capitalised, the auditor must ensure that the criteria
imposed by IAS 38 are satisfied.

¨ The costs for each project are measurable reliably.

180
 Chapter 12 The audit of non-current assets

¨ The costs are incurred for viable development expenditure as opposed to speculative
research.

¨ All purchases of capital assets are included in tangible non-current assets (but depreciation
written off should be included as part of the development expenditure).

¨ The outcome of the project can be assessed w ith reasonable certainty.

¨ The company is able to use or sell the completed item.

¨ The company has the resources to complete the project.

New development expenditure should be vouched in order to confirm the accuracy and
consistency of coding.

Research expenditure written off directly to revenue should be scanned in order to discover if
any sums have been wrongly debited to the income statement.

Any expenditure that has been scrapped should be reviewed with a suitable authorisation for
the treatment. The auditor should also consider whether such a write-off is consistent with
previous years or whether it requires disclosure as an exceptional item.

Amounts carried forward should be reviewed in the light of cost budgets in order to establish:

¨ whether management are controlling expenditure.

¨ the full comm itment of future expenditure that must be compared with budgets of
revenue.

W ritten confirmation should be obtained from the directors that they consider the amount to
be properly carried forward in order to satisfy IAS 38.

Cash forecasts and trading budgets should be reviewed for evidence that adequate resources
exist, or are reasonably expected to be available, to enable the project to be completed.

The presentation of the development expenditure under the appropriate balance sheet sub-
heading should be verified as in accordance with IAS 1.

4 The audit of quoted investments

4.1 Ownership and existence
Quoted investments may be held as a current asset (ie, for realisation in the near future) or as a
non-current asset. In this section the principles involved for verifying proof of ow nership,
existence and valuation are discussed.

The document of title is the share certificate w hich clearly show s:

¨ the name of the client as the registered holder.

¨ the denomination of shares.

7KHVKDUHFHUWLILFDWH V VKRXOGEHLQWKHFRPSDQ\·VSRVVHVVLRQDQGVKRXOGEHLQVSHFWHGRQWKH
last business day of the period, and compared against a schedule of investments prepared by
the client. The advent of paperless transfers may make this exercise relatively difficult.

: KHUHWKHGRFXPHQWVRIWLWOHDUHKHOGE\DWKLUGSDUW\ HJWKHFRPSDQ\·VEDQNHUV WKHDXGLWRU

will obtain a certificate that the securities are held for safekeeping only, and are free of any
FKDUJH 7KH UHOLDQFH RQ WKH FHUWLILFDWH Z LOO GHSHQG XSRQ WKH DXGLWRU¶V MXGJHPHQW RI WKH
reliability of the organisation providing it.

The evidence of existence will be provided by the following documents and procedures.

181
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH ,QWHUQDWLRQDO

¨ 3XUFKDVHV FRQWUDFW QRWHV DQG SDLG FKHTXHV VXSSRUWHG E\ GLUHFWRUV· PLQXWHV WR SURYLGH
proof of authority for purchase.

¨ Sold contract notes will provide evidence of disposals in the period.

¨ Vouching income received indicates that the investments were ow ned.

¨ Verification that all income has been received, by reference to published reference guides.

¨ Verification that all scrip issues have been accounted for and all rights issues have been
taken up by reference to published reference guides.

4.2 Valuation
If investments qualify as financial assets under IAS 39 then the choices available to the
management are as follows.

¨ 7RFDUU\WKHLQYHVWPHQWDWIDLUYDOXH²WKLVWUHDWPHQWLVWKHQRUPDO,$6DFFRXQWLQJIRUDOO
financial assets.

¨ 7R FDUU\ WKH LQYHVWPHQW DW KLVWRULFDO FRVW OHVV DQ\ DP RXQWV ZULWWHQ RII ² WKLV LV WKH
treatment for the historical cost convention, appropriate if a fair value cannot be reliably
measured.

In principle an investment held as a non-current asset must be treated just like any other non-
current asset and depreciation should be charged where appropriate. However, since the
expected life of an investment is normally infinite, in practice no depreciation w ill be charged.

4.3 Presentation
The auditor should satisfy him self that appropriate disclosures have been made. The tests
include the following.

¨ Comparing historical cost w ith market value in order to establish the validity of write-offs
or write backs.

¨ Verifying the fair value of investments by consulting stock exchange market values.

¨ Verifying the analysis of total balance sheet value between quoted and unquoted
investments.

4.4 Documents of title held by third parties

Although it is com monly accepted that an auditor can rely on certificates provided by a
reputable third party, there is no real substitute for a direct confirmation by inspection. In the
case of quoted securities, auditors should be aware of the risks of forged transfers w hich are
processed in good faith by the company in which the investment is held. Note that it is now
becoming increasingly comm on to hold investments in paperless form; brokers and
LQWHUPHGLDULHVFDQSURYLGH´SDSHUµHYLGHQFHRIWLWOHIRUWKHDXGLWRU

182
 Chapter 12 The audit of non-current assets

Practice question 1 (The answer is in the final chapter of this book)

Xantippe

Your firm acts as auditors to Xantippe Lim ited, a manufacturer of industrial components. You
have been presented w ith the draft financial statements for the year ended 31 M ay 20X6, which
include the following information in connection w ith tangible non-current assets.

At 1 June 20X5 Additions Disposals At 31 May 20X6

$ $ $ $
Cost
Freehold property 80,000 ² ² 80,000
Plant and machinery 438,000 62,000 10,000 490,000
Motor vehicles 40,500 13,000 ² 53,500
_______ ______ ______ _______
558,500 75,000 10,000 623,500
_______ ______ ______ _______

At 1 June 20X5 Charge for year Disposals At 31 May 20X6

$ $ $ $
Depreciation
Freehold property 8,000 1,600 ² 9,600
Plant and machinery 139,500 47,000 3,000 183,500
Motor vehicles 20,000 10,200 ² 30,200
______ ______ _____ ______
167,500 58,800 3,000 223,300
______ ______ _____ ______

Required

(a) Explain the factors that should be considered in determining an approach to the audit
of non-current assets of Xantippe Lim ited. (8 marks)

(b) State the procedures you would perform in order to reach a conclusion on non-current
assets in the financial statements of Xantippe Limited for the year ended 31 M ay 20X6.
(12 marks)

7RWDO²PDUNV

Approach to the question

Part (a)

: KHQHYHU D TXHVWLRQ LQFOXGHV WKH Z RUG ´DSSURDFKµ \RX VKRXOG LGHQWLI\ WKDW D GLVFXVVLRQ RI
various planning considerations is required. Not only that, but you w ill need to concentrate on
D VSHFLILF DUHD ² WKDW RI ULVN DQG PDWHULDOLW\ OHDGLQJ WR D VSHFLILF GHWHUPLQDWLRQ RI DXGLW
approach. The approach is a decision as to whether the auditor concentrates upon substantive
tests, tests of control or analytical review.

Also remember to use any illustrations from the question w herever possible.

Part (b)

If there are three categories in the question that you are asked to audit, then divide your
answer up into three categories as well. It is vital that your paper is clearly set out, making it as
easy as possible to mark.

183
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH ,QWHUQDWLRQDO

Practice question 2 (The answer is in the final chapter of this book)

Daybrook

Your firm is the auditor of Daybrook Insurance Brokers Limited which operates from a num ber
of branches and provides insurance for the general public and for businesses. The company
obtains insurance from large insurance companies, and takes a commission for its services. You
KDYH EHHQ DVNHG WR DXGLW FHUWDLQ DVSHFWV RI WKH FRPSDQ\·V QRQFXUUHQW DVVHWV IRU WKH \HDU
ended 31 M arch 20X5.

7KHFRPSDQ\·VPDLQQRQFXUUHQWDVVHWVFRPSULVH

¨ freehold land and buildings.

¨ microcomputers, printers and related equipment which are used by staff.
¨ cars which are provided to directors and salespeople who visit customers.

The company has been operating for a number of years, and it maintains details of its office
equipment and cars on a computerised asset register. The com pany uses the following
depreciation rates.

Buildings 2% per annum on cost

Office equipment (including computers) 10% per annum on cost
M otor vehicles (ie, cars) 25% per annum on cost

You are concerned that the depreciation rate for the computers may be inadequate.

2Q$SULO;'D\EURRN,QVXUDQFH%URNHUVSXUFKDVHGDFRPSHWLWRU·VWUDGHIRU7KLV
FRPSULVHGWKHFRPSHWLWRU·VFXVWRPHUVDQGWUDGHQDPHEXWLWGLGQRWLQFOXGHDQ\RWKHUDVVHWVRU
liabilities. In the financial statements for the year ended 31 M arch 20X5 the goodw ill has been
included in the balance sheet and it is being am ortised over a period of ten years.

Required

(a) Describe how you would verify the ownership of

(i) freehold land and buildings

(ii) computers and cars. (5 marks)

(b) (i) Describe the investigations you would carry out to determine whether the
depreciation rate of the com puters is adequate.

(ii) Describe the factors you would consider w hen deciding w hether to qualify
your audit report on the understatement of the depreciation of the com puters.

(iii) Assum ing you decide to qualify your audit report on the understatement of
depreciation on the office equipment, you should describe the form of
qualified audit report you w ould use. (8 marks)

(c) Describe the audit work you would carry out to determine w hether the goodwill on
SXUFKDVH RI WKH FRPSHWLWRU·V WUDGH LV ZRUWK  DW  0DUFK ; DQG WKDW WKH
amortisation charge of $50,000 is reasonable. (7 marks)

7RWDO²PDUNV

Approach to the question

The most comm on reason for failure w ith a question that is clearly divided up into sections is
to omit a section from the answer. For example, students fail to address the type of audit
qualification used, im mediately dropping two to three marks. This kind of trap should be
avoided by ensuring that you answer all parts of the question.

184
 Chapter 12 The audit of non-current assets

,QFOXGHDQ\GHILQLWLRQV ZKHUHYHU\RXWKLQN WKH\ PD\ EH UHOHYDQW VXFK DV ´GHSUHFLDWLRQµ DQG
´JRRGZ LOOµ 

W hen stating a test or procedure, you should evaluate the type of evidence. For example,
´FKHFN WKH FRQYH\DQFH UHSRUWµ 7KLV LV WKLUG SDUW\ H[WHUQDO HYLGHQFH DQG LV FRQVLGHUHG E\ WKH
auditor to be a reliable source. However, it should be ensured that the report is prepared by an
independent and properly qualified conveyancer.

W hen attempting to list and explain audit tests for the m ore unusual balance sheet areas
(although it does w ork for the more standard ones as well) you may wish to use the following
mnemonic.

C Cost

A Authorisation

V Valuation

E Existence

B
Beneficial ow nership
O

P Presentation

Each letter (the B and O being combined) represents an audit test area.

Cost²LQLWLDOYDOXHLQWKHEDODQFHVKHHW

Authorisation²LVLWDOHJLWLPDWHFRVW"

Valuation²DUHZHDVDXGLWRUVKDSS\ZLWKWKHDP RXQWLQFOXGHGRQWKHEDODQFHVKHHWRUVKRXOG
it be altered?

Existence²LVWKHDVVHWRUOLDELOLW\´UHDOµ"

Beneficial ownership²GRHVLWEHORQJRUSHUWDLQWRRXUFOLHQW"

Presentation²LVLWUHFRUGHGFRUUHFWO\LQWKHILQDQFLDOVWDWHPHQWV"&RUUHFWO\PHDQVLQDFFRUGDQFH
with the relevant accounting framew ork.

For something like goodwill it is useful to break dow n audit procedures into these sub-
KHDGLQJVLQRUGHUWRSURGXFHD´IXOOµDQVZHU7Z RSRLQWVRIZDUQLQJ

<RX ZLOO QRW DOZD\V EH DEOH WR WKLQN RI D WHVW IRU HDFK DUHD ,I \RX FDQQRW GR QRW ZRUU\ ² DW
least you are trying to cover every aspect and your answer will be better for doing so.

Do not use the CAVEBOP headings in your answer as there is a danger of attempting to fit the
question to the answer instead of the other way around. Note that this question requires you to
concentrate upon ow nership, cost and valuation.

185
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH ,QWHUQDWLRQDO

The following question is purely based around a scenario that talks about intangible assets, but
also includes four marks on form s of audit report.

Practice question 3 (The answer is in the final chapter of this book)

Hyson

Your firm is the auditor of H yson Computers Limited. You have been asked by the audit
PDQDJHU WR DXGLW FDSLWDOLVHG GHYHORSPHQW H[SHQGLWXUH DW WKH FRPSDQ\·V \HDU HQG RI  $SULO
20X6.

Hyson Computers Lim ited is a company w hich writes software and develops m icrocomputer
systems. It sells the software to retailers or direct to small businesses. In 20X4, the managing
director felt there w ould be a market for combining a microcomputer, printer and scanner to
produce a system for small businesses. W ork on developing this system started in M ay 20X5.
The expenditure incurred comprised the following elem ents.

¨ Purchase of computers, scanners, modems and printers to develop the system.

¨ Purchase of standard software for performing various tasks.

¨ W riting special software to allow the follow ing functions to be performed, often at the
same time:

(i) Normal operation of the com puter for accounting and other functions.

(ii) Use of the scanner to send faxes by telephone, and use of the printer to print faxes
received by the business.

(iii) Use of the scanner and printer as a photocopier.

(iv) Use of the scanner to input images into the com puter, and software to convert
written images into text.

$WWKHFRPSDQ\·V\HDUHQGRI$SULO;KDVEHHQVSHQWRQGHYHORSLQJWKHV\VWHP
The managing director says:

¨ the system is almost ready for selling to customers.

¨ there has been a lot of interest from customers.

¨ a few selected customers have been given test systems to see if it meets their needs and
report any problems.

In the draft financial statements for the year ended 30 April 20X6 this development
expenditure has been capitalised at $500,000.

The audit manager has explained to you that any research and development expenditure
FDSLWDOLVHG LQ WKH FRP SDQ\·V ILQDQFLDO VWDWHPHQWV P XVW FRPSO\ ZLWK WKH FRQGLWLRQV RI ,$6 
Intangible Assets. He has sum marised these conditions as follow s.

¨ There is a clearly defined project.

¨ The expenditure must be measurable reliably.

¨ The project must be technically feasible and com mercially viable.

¨ The total deferred development costs are expected to be exceeded by future sales less
associated costs.

¨ The company intends to com plete the project.

¨ The company has adequate resources to complete development and sell the product.

186
 Chapter 12 The audit of non-current assets

Required

(a) Describe the audit work you will carry out to verify the expenditure of $500,000 on
development of the software and hardware system described above. (8 marks)

(b) Describe the matters you will consider and the investigations you will carry out in
deciding w hether development expenditure of $500,000 can be capitalised in the
financial statements. (8 marks)

(c) Consider and describe the form of qualified or unqualified audit report you will give,
in each of the two situations below, if the directors refuse to amend the financial
statements, and you come to the conclusion:

(i) there is a risk that the $500,000 capitalised development expenditure w ill not
be recoverable; and

(ii) that it is not possible for the company to develop a comm ercially viable
product, so there will be no sales, and the $500,000 capitalised development
expenditure is worthless. (4 marks)

7RWDO²PDUNV

In part (c) you should assume that the $500,000 deferred development expenditure is material,
but that if it is valueless, it w ill not create going concern problems.

Approach to the question

You must keep your answers relevant. Part (a) is telling you that the category criteria to allow
an item to be treated as development expenditure have been met so the tests performed can
cover the normal CAVEBOP headings.

Part (b) is asking you to forget the assumption that the criteria are being met and to test
whether or not the $500,000 can be treated as development expenditure.

'RQ·WIRUJHWWRLQFOXGHDGHILQLWLRQRIUHVHDUFKDQGGHYHORSPHQW

You should also realise that development expenditure only includes costs that otherwise w ould
be written off to the income statement such as labour and overheads. Any tangible non-current
assets purchased for use in either a research or a development project are capitalised under the
tangible non-current asset category and written off over their estimated useful life accordingly.

5 Summary
Audit objectives associated with the verification of non-current assets are as follows.

¨ Ow nership
¨ Existence
¨ Valuation
¨ Presentation

M ore fully, these can be sum marised in the m nem onic CAVEBOP.

Controls over tangible non-current assets should cover recording, authorisation, custody, and
general managerial supervision.

The main intangible assets likely to be exam ined are goodwill and development expenditure.

Quoted investments held as non-current assets are subject to many of the same audit
procedures as tangible and intangible non-current assets. However, special problem s may arise
if documents of title are held by third parties (such as a broker or a bank).

W here the auditor finds weaknesses in the system s for dealing with revenue and capital
expenditure, he should report those weaknesses to management in accordance with ISA 260.

187
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH ,QWHUQDWLRQDO

188