AUDIT RISK IN P2 STANDARDS

INTANGIBLE NON-CURRENT ASSETS - IAS 38

The key audit risk is whether the item meets the criteria to be recognized as an
intangible asset or not.
An intangible asset is an identifiable non-monetary asset without physical
substance. It may be held for using in the production and supply of goods or
services or for rentals to others or for administrative purposes. The asset must be:

Controlled by the entity as a result of events in the past, and

Something from which the entity expects future economic benefits to flow.

Important
Internally generated goodwill will not be recognized as an asset.
IAS 38 forbids the capitalization of internally generated brands.
The following procedures are necessary:

Prepare analysis of movement on cost and amortization accounts

Obtain confirmation of all patents and trademarks held by a patent agent
Verify payment of annual renewal fees
Review specialist valuation of intangibles such as
o Qualification of valuer
o Scope of work
o Assumptions and method used
Inspect purchase agreement
Confirm purchases have been verified
Review amortization for clerical accuracy
Confirm amortization rates are reasonable

The following procedures are relevant specifically for goodwill:

Agree consideration to sales agreement

Confirm valuation of assets acquired
Check purchased goodwill is calculated correctly
Check goodwill does not include non purchased goodwill
Review amortization calculation for accuracy
Review amortization rate for reasonableness
Review impairment review for reasonableness
Review useful life for reasonableness

Research and Development cost

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Research: is original and planned investigation undertaken with the prospect of

gaining new scientific or technical knowledge and understanding.
Development: Is the application of research finding for the development of new
or improved goods and services prior to the commercial production or use.
Important:
Expenditure on research should be expensed out and not capitalized.
Expenditure on development may be capitalized subject to the fulfillment of
following criteria.

Completion of the asset is technically feasible.

The business will be able to complete the asset and use or sell it.
The business can demonstrate how future economic benefit will be
generated.
Adequate technical, financial and other resources will be available to
complete the asset
Expenditure attributable to the development of asset can be measured
reliably

Following audit procedures are necessary:

Check project is clearly defined

Check related expenditures can be separately identified
Examine market research reports, feasibility studies, budgets and forecasts
Consult clients technical experts
Review budgets revenues and costs by examining results to date, production
forecasts, advance orders and discussion with directors
Review calculations of future cash flows to ensure resources exists to
complete the project
Review previously deferred expenditures to ensure IAS 38 criteria still justified
Check whether amortization commences with production and charged on
systematic basis

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FINANCIAL INSTRUMENTS IFRS 7 and IFRS 9

Financial instruments, particularly complex ones, increases audit risk. Factors which
increase audit risk include the following:

Lack of management understanding of financial instruments and therefore

inadequate management control
Inappropriate classification of financial instruments. This will affect gearing
and therefore the risk profile of the business. This is particularly an issue
where hybrid or compound instruments have been issued with both debt and
equity elements.
The use of fair values involves the use of valuation techniques including
market estimates.
Recognition of the costs associated with the instrument is not necessarily
straight forward. For example, the discount on discounted debenture should
be treated as a part of the overall cost of the instrument and recognized over
the life of the debenture

The following audit procedures will normally apply:

Review the terms of the financial instrument and confirm that they have been
classified in accordance with their substance. Enquire of management as to
their intention i.e. to sell in the short term or hold to maturity. Corroborate
any statement by a review of events after the reporting period, forecast and
projection.
For listed shared the auditor can check the company exists by reviewing
stock exchange listing. Unlisted companies can be verified by simple
enquiries from the company registry.
Confirm that all financial assets and liabilities have been valued at fair value
where this is required by IFRS 9. Agree fair value to transaction price. Where
part of the consideration has been given for something other than financial
instrument, assess valuation technique adopted, e.g. discounting of future
cash flows.
Where there is an active market agree fair value to quoted market price.
Where there is no active market assess the valuation technique adopted by
management and any assumptions made.
Ownership of shares in another company should be checked to the share
certificate. The share certificates may be kept in a bank or at a broker, in
which case the auditor should confirm with these parties that the share
certificate exists.

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Check disclosure complies with IFRS 7. This includes e.g. qualitative

disclosures about exposure to risk and risk management, and quantitative
disclosure of summary data about exposures.

FOREIGN EXCHANGE RATES IAS 21

Individual Company
The most immediate audit risk is that entity fails to comply with the accounting
rquirements of IAS 21 The Effects of Changes in Foreign Exchange Rates. For
an individual company conducting trade in foreign currencies there are two separate
issues: conversion and translation.
Conversion is relatively easy and relates to an entity conducting transactions in a
foreign currency and which incurs exchange gain or loss in relation to these
transactions. The rule is simple: the gain or loss on conversion is recognized directly
in profit and loss in the period in which it occurs. The principal risk here is of wrong
rate being used, resulting in misstatement of the gain or loss in the financial
statements.
Translation is more complex. Translation is required at the end of an accounting
period when a company still holds assets or liabilities which were obtained or
incurred in foreign currency. IAS 21 distinguishes between monetary items and non
monetary items. The basic rule is that monetary items e.g. cash and receivables
should be retranslated using the rate rule at the end of each accounting period.
Non-monetary items are left at the amount recognized at the date of transaction.
Audit procedures here would therefore include:

Check that monetary items included in the statement of financial position at

the yearend are translated at the closing rate of exchange.
Check that non-monetary items are translated at the historical rate of
exchange.
Check that items are included in the statement of comprehensive income at
the historical rate of exchange.

Groups
It is also possible that parent company may have overseas subsidiaries. It must
translate the financial statements of those operations in to its own reporting

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currency before they can be consolidated in to group accounts. There are two
methods of achieving this. The method depends on whether the foreign operation
has the same functional currency as the parent.
Same functional currency
Income statement
Non monetary
items
Monetary items
Exchange
difference

Transaction or average rate (where there is no significant

fluctuations)
Historic rate
Closing rate
Report as part of profit or loss for the year

Different functional currency

Assets and
liabilities
Income statement
Exchange
differences

Translate at the closing rate (The balancing figure on the

translated statement of financial position represents the
reporting entitys net investment in foreign operation
Transaction or average rate (where there is no significant
fluctuations)
Taken to equity

Other issues
1.
2.
3.
4.

Hyper inflationary trends

Subsidiary may have been audited by component auditors
Different accounting frameworks
Possible difficulty in the parent being able to exercise control e.g. due to
political instability or laws and regulations
5. Currency restrictions limiting payment of profits to the parent

REVENUE IAS 18
Revenue is commonly audited by analytical review. This is because revenue should
be predictable and there are good bases on which to base analytical review, such
as:

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Plenty of information, for example, last years account, budget, monthly

analyses
Logical relationships with items such as inventory and receivables

Unless complex transactions arise where revenue is not as clear cut as a product
being supplied and invoiced for, revenue recognition is generally not an issue.
However in some companies, for example, those that deal primarily in construction
contracts, revenue recognition can be a material issue. Example of industries where
this might be true:

Building industry
Engineering industry

In such industries, auditing revenue recognition will be part of auditing construction

contracts. The auditor should:

Consider whether the basis for recognition is reasonable

Agree revenue recognized to relevant documents (for example work
certificates or contracts)

However, it should not be thought that revenue recognition is generally a low risk
area to audit. Far from it: revenue recognition is one of the commonest areas of
fraudulent financial reporting. Indeed, ISA 240 The Auditors responsibilities
Relating to Fraud in An Audit of Financial Statements states that the auditor
should presume that there is a risk of fraud in relation to revenue recognition and
should obtain an understanding of the controls related to those risks.
The following recognition criteria are important:
Sale of Goods
The entity should only recognize when:

Significant risks/reward of ownership of goods are transferred

It has no continuing managerial involvement over goods
Revenue can be measured reliably
Probable that economic benefits will flow to enterprise
Cost incurred can be measured reliably

Rendering of Services

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An entity should recognize revenue depending on the stage of completion of the

transaction. Outcome can only be reliably estimated when:

Revenue can be measured reliably

Probable economic benefits will flow to the entity
Stage of completion at year end can be measured reliably
Cost incurred can be measured reliably

Interest
Time proportion basis
Royalties
Accrual basis, per agreement
Dividends
When shareholders gain right to receive payments

GOVERNMENT GRANTS IAS 20

Government Assistance: Action by government designed to provide an economic
benefit specific to an entity or range of entities qualifying under certain criteria.
Government Grant: Assistance by government in the form of transfers of
resources to an entity in return for past or future compliance with certain conditions
relating to the operating activities of the entity. It excludes transactions with
government which cannot be distinguished from the normal trading transactions of
the entity.
Grants related to assets: Government grant whose primary condition is that an
entity qualifying for them should purchase, construct or otherwise acquire long term
assets.
Grants related to income: Government grant other than those related to assets.
Revenue grants are relatively easy to audit as compared to capital grants.
Following is the summary of accounting treatment in this regard:

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Recognize government grant and forgivable loans once conditions complied

with and receipt/ waiver is assured.
Grants for depreciable assets should be recognized as income on the same
basis as the asset is depreciated.
Grants for non-depreciable assets should be recognized as income over the
periods in which the cost of meeting obligation is incurred.
A grant may be split into parts and allocated on different bases where there
are a series of conditions attached.
Where related costs have already been incurred, the grant may be recognized
as income in full immediately.
A grant in the form of non-monetary asset shall be valued at fair value.
Grants related to assets may be presented in the statement of financial
position either as a separate credit or deducted in arriving at the carrying
value of the asset.
Grants related to income may be presented in the statement of
comprehensive income either as a separate credit or deducted from the
related expense.
Repayment of government grants should be accounted for as a revision of an
accounting estimate.

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