Audit of intangible non-current assets

A software company reports ₦55 million as an intangible asset for a product it is developing. The auditor cannot inspect it, count it or send it to the bank for confirmation. Intangible assets have no physical form, so the auditor tests the evidence behind the figure: was a business really bought, are the conditions for capitalising development costs met, and is the asset worth what the books say?

The examiners like this area because the rules, mainly IAS 38, can be tested step by step.

This topic covers the risks and substantive procedures for purchased goodwill, other intangible assets and development costs, including the six criteria for capitalising development costs under IAS 38. The previous topic covered tangible assets, and the next covers inventory.

Key terms in plain English

Syllabus check

This topic is in syllabus area C, audit evidence and substantive procedures (25% of marks). It covers:

• substantive procedures for intangible assets
• recognition of development costs under IAS 38
• tests of existence and valuation

CAMA 2020 and intangible assets

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

Substantive procedures for intangible assets

The risks and procedures for intangible assets such as goodwill and brands are similar to those for tangible assets. The emphasis is on existence and valuation. Remember that the only intangible assets that can be recognised in the statement of financial position are:

• purchased goodwill
• intangibles with a readily ascertainable market value or acquired at a cost
• development costs that meet the conditions in IAS 38

Internally generated goodwill and brands are not recognised, so the auditor also checks that they have not been capitalised. There should be adequate evidence to reach a conclusion on these assets.

Tests of detail for purchased goodwill

These relate mainly to valuation:

• confirm that a business was acquired and confirm the consideration paid. This checks existence as well as valuation;
• review the reasonableness of the valuation of the net assets acquired;
• check the calculation of goodwill, which is the consideration paid less the fair value of the net assets acquired;
• review for the possibility of impairment; and
• ensure that any impairment loss was correctly calculated and recorded in the ledger.

For acquisitions, the auditor also reads the sale and purchase agreement and the board minutes approving the deal, agrees payment to the bank statements, checks that the acquisition date was properly identified and that the fair value exercise included all identifiable assets and liabilities, including contingent liabilities, and considers whether the expert used for the valuation is competent.

Goodwill is tested for impairment at least once a year, because it is not amortised under IFRS. The auditor reviews the cash flow forecasts and the discount rate and growth assumptions, compares them with actual results, and does a sensitivity test.

Tests of detail for other intangibles

Excluding development costs, the tests resemble those for tangible assets:

• confirm existence, cost and the entity's legal rights by looking at the purchase documents;
• check the amortisation calculation using the entity's stated policy;
• consider the possibility of impairment, which may need discussion with the directors; and
• ensure that any impairment is correctly dealt with in the ledger.

Examples include licences, patents, trademarks, software and franchise rights. The auditor also checks that the useful life is reasonable and reviewed each year, and that assets with an indefinite life are tested for impairment annually. For a licence the auditor reads the agreement for its term, renewal rights and restrictions.

Development costs: the criteria in IAS 38

The tests for development costs must let the auditor conclude whether the IAS 38 conditions for recognition are met. An intangible asset arising from development, or from the development phase of an internal project, is recognised if, and only if, the entity can demonstrate all of the following:

1. Technical feasibility of completing the asset so it will be available for use or sale.
2. Intention to complete it and use or sell it.
3. Ability to use or sell it.
4. Probable future economic benefits, shown among other things by the existence of a market for the output or the asset itself, or its usefulness if used internally.
5. Adequate resources, technical, financial and other, to complete the development and use or sell it.
6. Ability to measure reliably the expenditure attributable to the asset during development.

Research costs are always expensed. Costs incurred before the criteria are met are expensed and may not be reinstated later. Only costs from the date all the criteria are met are capitalised.

Tests of details for development costs

• Discuss the project with management, other senior staff and key stakeholders to assess feasibility: review projections and forecasts of resource use and benefits; assess production and marketing plans and whether a market or use exists; consider funding to completion; consider whether the entity will be able to use or sell the asset; and discuss management's intention to complete it and use or sell it.
• Inspect development contracts and records supporting and safeguarding patents.
• Test controls over the documentation and safekeeping of scientists' notes, findings and conclusions.
• Test a sample of development costs for appropriate capitalisation: agree to invoices and time records, and check that the costs are directly attributable and fall in the development phase.
• Obtain a written representation from management on their commitment to complete the project and use or sell the asset.

The auditor also checks that amortisation starts when the asset is available for use, that the method reflects the pattern of benefits, and that there is no indication of impairment while the asset is not yet in use, since projects not yet complete must be tested for impairment every year.

Answering a question on development costs

When a question asks for audit procedures for an intangible asset figure, give procedures that gather different kinds of evidence: enquiry (discussion with management), inspection (contracts, patents, invoices), recalculation (costs and amortisation) and representation. Say what each shows. A list of five procedures with a one-line purpose each usually scores best.

When it asks for criteria, give the six IAS 38 criteria, stated in terms of the entity, and a short note on what each means.

Worked examples

1. Goodwill is ₦200 million.
2. The auditor confirms the payment and the agreement, tests the fair values, recalculates goodwill and reviews impairment.

1. Probable future economic benefit and resources are not shown.
2. The costs should be expensed. The auditor proposes the adjustment.

1. That is research, which is always an expense.
2. Only costs after all six criteria are met can be capitalised.

1. Annual amortisation is ₦6 million, so carrying amount is ₦66 million.
2. The auditor recalculates and checks the life and the impairment indicators.

How to score full marks

• State that the focus is on existence and valuation.
• Give the six IAS 38 criteria in full.
• Vary the type of procedure: enquiry, inspection, recalculation, representation.
• Link each procedure to the criterion it tests.

Common mistakes in the exam

• Capitalising research.
• Forgetting impairment of goodwill.
• Listing the criteria without explaining them.
• Giving only tests for tangible assets.

Quick revision

• Existence and valuation.
• Goodwill: consideration less fair value of net assets; impairment.
• Six criteria for development costs.
• Tests: discuss, inspect, test controls, sample costs, representation.

Practice questions

Questions 1 to 10 are multiple choice. Questions 11 to 13 are written. Try each before opening the answer.

Model answers

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