According to IAS 38, Intangible Assets are “resources controlled by the entity” which are expected to contribute future economic benefits to the entity, “lack physical substance and are identifiable”. Some examples of Intangible Assets are goodwill, development costs, copyrights, patents, trademarks, and long-term investments.
Except for Intangible Assets with indefinite useful lives, Intangible Assets are very similar to Fixed Assets in the sense that they are also subject to amortization. In addition, they would need to be tested annually for impairment in accordance with IAS 36.
Before the auditors decide what procedures to perform, the risks associated with auditing Intangible Assets should first be identified:
- Risk of Material Misstatement: The risk is high as a lot of judgment is needed to determine the value of Intangible Assets. Examples include incorrect capitalization of costs such as research costs, wrong estimates of useful lives, and amortization rate as well as management bias in impairing the assets as it could lower profit.
- Control Risk: There are multiple Control Risks for Intangible Assets. These include lack of expertise and experience of those determining the fair value of the Intangible Assets, lack of control over the processes used to measure the fair value of an Intangible Asset, no segregation of duties between those committing the entity to the purchase and those undertaking the valuations, significant assumptions used by management in determining fair value, etc.
- Detection Risk: Detection Risk is technically the risk that an auditor is not able to detect the material misstatements in the reported amounts of Intangible Assets.
The audit risk for Intangible Assets is usually high as this is a complex area.
For an auditor to be reasonably assured of the Intangible Assets balance, tests will be performed to cover the relevant audit assertions. The assertions applicable to Intangible Assets are as follows:
- Completeness: All Intangible Asset transactions during the accounting period have been properly recorded in the financial statements.
- Rights and Obligations (Ownership): The entity owns the Intangible Assets and has rights for them as of the reporting date.
- Valuation: The cost of capitalization and recoverability of the Intangible Assets compared to their netbook values are properly evaluated.
- Existence: Intangible Asset reported on the balance sheet actually exists at the reporting date.
- Presentation and Disclosure: The Intangible Asset balance is correctly presented as non-current assets on the balance sheet and adequate disclosures on accounting policy, significant purchases and disposals have been made in the notes to the financial statements.
Audit Procedures for testing Intangible Assets include Test of Controls and Substantive Tests.
Test of Controls:
Controls relevant to Intangible Assets are generally very similar to that of Fixed Assets. They include addition and disposal of Intangible Assets, segregation of duties, impairment policy, and amortization policy.
- Addition and Disposal of Intangible Assets: This to make sure each addition and disposal is processed, reviewed, authorized, and approved by different persons (segregation of duties) in the entity following the authorization matrix stated in the entity’s policy.
- Segregation of Duties: The person performing the valuation for the Intangible Assets should be different from the person in charge of the purchase. This will reduce the likelihood of bias that may cause an overstatement in the asset balance.
- Impairment Policy: Having this control in place allows the entity to properly identify assets that need to be impaired on a timely basis. Without this in place could lead to an overstatement of assets especially when there is a downturn in the entity’s business.
- Amortization Policy: This control is imposed to ensure that management has amortized the relevant Intangible Assets correctly based on their useful lives.
Substantive Audit Procedures for Intangible Assets:
Substantive Audit Procedures for Intangible Assets consist of the following components:
1) Substantive Analytical Procedures:
Substantive Analytical Procedures include the consideration of whether there are any major changes in the entity’s operations. One example of this would be the acquisition of other companies or business combinations.
This will allow the auditor to anticipate an increase in the Intangible Asset balance and further investigation should be carried out if the expectation is not met.
The same applies to disposal. We should take note if there is any disposal of a business line, especially one that has goodwill attached to it. Such change is an indication that the Intangible Assets should be classified as assets held for sale or be written off.
If the Intangible Assets need to be written off, we need to determine if they have been reflected in the level of disposals. Test of details is normally performed for this purpose.
Other than the above, we should also be wary of any downturn in the business as it may give rise to an indication of impairment. If such a condition exists at the end of the accounting period, a test of details should be performed to ensure the relevant assertions are covered.
2) Test of Details for Intangible Assets:
To test details for Intangible Assets, audit procedures are designed around assertions. Example and description of test of details are given in the table below:
|Audit Assertion||Example of Audit Procedure|
|Completeness||Reviewing the development costs incurred by the entity to ensure all eligible costs have been properly capitalised based on the relevant accounting standard.|
|Rights and Obligations||Inspecting the sale or purchase agreements of the Intangible Assets to ensure the entity is the rightful owner of these assets.|
|Valuation||Testing the useful lives and amortisation rate of the Intangible Asset samples to ensure they are appropriate and in line with the entity’s accounting policies. Recalculating the impairment estimate done by management to ensure it is reasonable and followed an acceptable accounting standard.|
|Existence||Inspecting the original supporting documents, such as the legal documentation of a trademark, license or patent to ensure its existence on the balance sheet as at the reporting date.|
|Presentation and Disclosure||Reviewing the financial statements prepared by the entity and identifying if information regarding Intangible Assets has been sufficiently disclosed in accordance with the applicable accounting standard.|