When you are auditing items appearing in the financial statements, you need to consider the following matters:

  • Risk,
  • Materiality,
  • Relevant accounting standards,
  • Audit evidence.




The key audit objectives are existence, completeness, valuation and rights and obligations.


Inventories of Stock, Work in Progress and Finished Goods

The auditor needs to evaluate whether the valuation of stock is reasonable.  IAS 2 states that stock should be measured at the lower of cost and net realisable value.  Costs would include cost of purchase and any other costs incurred in bringing the stock to its present condition and location.


Audit work specific to inventories

This will cover areas such as quantities, identification, condition, cut-off and valuation.

  • Review the written count instructions issued to client staff. Evaluate whether the instructions if followed are likely to derive an accurate count.
  • Attend at count and assess whether count is in accordance with instructions.
  • Carry out test counts at physical stock-take and check against client records. Note counts of specific items for further testing at final audit stage.
  • Ensure there is adequate control over the issue and return of all count sheets.
  • At the final audit stage, agree all items noted on stock count to the final evaluation.
  • Ensure that all staff responsible for counting have the necessary expertise to ensure all items are identified and counting accurately.
  • Test identification of individual items with appropriate catalogues etc.
  • Compare a sample of descriptions from the valuation back to the rough stock sheets.
  • Test the condition of a sample of items on the stock count making note of any items that appear damaged or appear to have been around for a long time.
  • Ensure that items noted as less than perfect are written down in the final valuation.
  • Observe at count whether there is movement of stock and assess the controls over the control of movement of stock on the day of the count.
  • Make a note of the last despatch note and the last goods inward note written.
  • Carry out sample tests to ensure sales/purchases are accounted for in the correct period.
  • Select a sample of prices in the final valuation and agree back to supplier’s invoices.
  • Select a sample of prices used and assess their net realisable value.
  • Review the stock note in the accounts to assess whether there is appropriate disclosure.
  • Review the letter of representation to ensure there is an adequate reference to stock.


The method of stock valuation may be based on unit cost, FIFO, LIFO or average stock.  The auditor should determine whether the method used is appropriate and properly applied.  Manufacturing stock valuation may also incorporate labour costs and production overheads.


Standard costing


IAS 2 allows standard costing to be used where prices are fluctuating.  The auditor should ensure that the standard costing is appropriate in the circumstances and that the calculation of the standard cost is reasonable.


In evaluating the appropriateness of standard costing you must consider whether prices are in fact fluctuating, whether this is the best accounting policy, if the policy has changed from the previous year how do the two years compare and is their sufficient disclosure.


In assessing the reasonableness of the calculation you must review the specific calculation, check the calculations, review them for reasonableness and verify specific elements of the calculation to source documentation such as purchase invoices, wages and overheads.


Construction contracts

 IAS 11 sets out the following accounting treatments:

  • Contract revenue and cost should be recognised in the period in which the work is performed.
  • An excess of total costs over total revenue should be recognised as an expense.
  • Any costs incurred, which relate to future activity should be recognised as an asset if it is probable that they will be recovered. (work in progress)
  • Where amounts have been recognised as contract revenue, but their recoverability becomes doubtful, recognise as an expense and not as a deduction from revenue.


The auditor should ensure that revenue and expenses have been correctly recognised and that any asset recognised for cost incurred in relation to future activity are recoverable.


Procedures that might be employed would include:

  • Verify revenue figures to certification of work completed,
  • Verify cost figures to invoices and ensure that they relate to the current period,
  • Ensure that capitalised costs relating to future activity are verified by reviewing invoices and work schedules,
  • Review contract to ensure that capitalised costs are recoverable,
  • Undertake bad debt review and ensure that any debt that is not collectable has been treated as an expense.


Non-Current Assets

 The auditor will concentrate on areas such as rights and obligations, valuation, existence, occurrence and presentation and disclosure.  Specific tests would include:

Reconcile opening figures, from last year’s file to the current accounting records.

Obtain a summary of assets analysed into categories such as cost, additions, disposals, depreciation and net book value.  Agree these figures to source documentation. Review the nominal ledger accounts and asset registers for any unusual items.

  • Verify title to assets by inspection of title deeds and land registry certificates.
  • Obtain list of additions and verify ownership by inspection of architect’s certificates, invoices etc. Check that purchases have been authorised.
  • Review for evidence of charges in statutory books and by company search.
  • Examine invoices received after the year end, orders and minutes for evidence of capital commitments which may require disclosure.
  • Verify costs of additions to supplier’s invoices.
  • Check that costs have been capitalised correctly.
  • Where the clients have used their own labour to construct assets, ensure that materials, labour and overheads have been correctly analysed and are properly charged to capital.
  • Review depreciation rates applied in relation to assets lives.
  • For revalued assets, ensure that the depreciation is charged on the revalued amount.
  • Ensure no further depreciation has been provided on fully depreciated assets.
  • Check valuation by inspecting any recent valuation certificate and considering the experience of a valuer, scope of his work and methods and assumptions made.
  • Review insurance policies for all categories of tangible non-current assets and consider the adequacy of their insured values and check expiry dates.
  • Consider any evidence of permanent diminution in value e.g. physical inspection, asset no longer used etc.
  • Make physical inspection of a sample of items and confirm that they are recorded in the asset register and the accounting records.
  • Reconcile the asset register to the accounting records.
  • Obtain or prepare a list of disposals and scrappings from non-current assets during the year. Reconcile original cost with sale proceeds and verify book profits and losses.  Check assets have been deleted from the asset register.
  • Consider whether disclosure complies with legislation and accounting standards.


Lack of an asset register

 If a non-current asset register is not kept, the auditor should obtain a schedule of all the major items of non-current assets showing the original cost and estimated depreciated value.  He should reconcile both the cost and depreciated value with the draft accounts.


In the absence of an asset register, the auditor is faced with a problem in relation to disposals.  Where there is a schedule of items from previous years the continuing existence of assets may be checked to this schedule but where there is none the auditor will have to rely more on a scrutiny of the cashbook for any large unexplained receipts and management representations.


At the end of the day the auditor may well conclude that there is material uncertainty as to the existence and valuation of non-current assets and be forced to give an appropriate qualification in their audit report in that they will not have received all the information and explanations considered necessary for the purposes of their audit.


IAS 36 states that tangible and intangible assets should be recorded in the financial statements at no more than their recoverable amount.  In certain circumstances, assets should be subject to an impairment review:

  • Assess whether a review might be necessary from knowledge of the business
  • Obtain the clients workings of the impairment loss
  • Consider whether they are reasonable and recalculate to ensure they are correct.
  • If possible verify new value to documentation such as a valuer’s report.


Intangible non-current assets

These types of assets usually include patents, licences, trade-marks, copyrights, franchises, development costs and goodwill.  All intangibles should be subject to an annual impairment review.


An intangible asset is an identifiable non-monetary asset without physical substance.    The asset must be controlled by the enterprise as a result of events in the past and something from which a company expects future economic benefits to flow.


An item should not be recognised as an intangible asset unless it fully meets the definition in the standard.  Internally generated goodwill may not be recognised as an asset.


The following procedures should be carried out by the auditor:

  • Prepare analysis of movements of cost and amortisation to test completeness.
  • Obtain confirmation of all patents and trademarks held by a patent agent and verify payment of annual renewal fees for testing rights and obligations.
  • For valuation testing, review specialist valuations of intangibles assets considering qualifications of valuer, scope of work and assumptions and methods used.
  • Confirm that balances brought forward represent continuing value.
  • Inspect purchase agreements and supporting documentation for intangible assets acquired in the period and confirm purchases have been authorised
  • Verify amounts capitalised of patents developed with supporting costing records
  • Review amortisation by checking computations and confirm that rates are reasonable.


Income from intangibles

Review sales returns and statistics to verify the reasonableness of income derived from patents, trademarks licences etc. and examine audited accounts of third party sales covered by patent, licence or trademark owned by the company.



Key tests are as follows:

  • Agree consideration to a sales agreement,
  • Confirm valuation of assets acquired is reasonable,
  • Check purchased goodwill is calculated correctly,

Check goodwill does not include non-purchased goodwill,


Ensure management have carried out an annual impairment review and assess whether their conclusions are reasonable,

Ensure valuation of goodwill is reasonable reviewing prior years accounts and discussion with the directors.


Development costs

 These costs may be included in the balance sheet only in circumstances specified in IAS 38.


It defines research and development as original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.

Development is the application of research findings or other knowledge to a plan or design for the production of a new or substantially, improved materials, devices, products, processes or systems prior to the commencement of commercial production or use.


Expenditure in research is required to be written off in the year of the expenditure.

IAS 38 states that development costs of a project should be recognised as an asset only when all of the following criteria are met:

  • Completion of the asset will be technically feasible,
  • The business intends to complete the asset,
  • The business will be able to use or sell the asset,
  • The business can demonstrate how future economic benefits will be generated, Adequate technical and financial resources are available to complete the development,
  • Expenditure attributable to the development of the asset can be measured reliably.


General overheads, costs of inefficiencies and expenditure on training staff to operate the asset should not be capitalised. Amortisation of development expenditure should not exceed 20 years and an appropriate method should be used.


The development costs of a project should not exceed the amount that is likely to be recovered from related future economic benefits, after deducting further development costs, related production costs, and selling and administrative costs directly incurred in marketing the product.  In all other circumstances development costs should be written off in the year of the expenditure.


The key audit tests largely reflect the criteria laid down in IAS 38:

  • Check accounting records to confirm project are clearly defined (i.e. separate nominal ledger codes) and related expenditure can be separately identified and certified to invoices timesheets etc.
  • Confirm feasibility and viability by examining market research reports, feasibility studies, budgets and forecasts and consult client’s technical experts.
  • Review budgeted 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 exist for completion.
  • Review previously deferred expenditure to ensure IAS 38 criteria are still justified.

Check amortisation so as it starts with production and is charged on a systematic basis.


Most companies have a policy of write off in the year.  With regard to these circumstances, the auditor should consider whether the profit and loss charge for research and development is complete, accurate and valid.


The key accounting issues with regard to brands is whether the asset is internally generated or not.  IAS 38 forbids the capitalisation of internally generated assets.

If a brand has been purchased separately, then the auditor should test the value of the brand according to the sales documentation.



 When auditing investments, the auditor needs to consider the income and the asset.


Investments can fall under the following headings:

  • Investments in companies whether listed or unlisted and their income, Investment in subsidiary and associated companies,
  • Investment properties.


There are a couple of key internal control considerations:

  • Authorisation over investment dealings,
  • Segregation of duties re the recording and custody roles should be kept separate.


Stockbrokers should not normally be entrusted with the safe custody of share certificates on a continuing basis since they have ready access to the stock exchange.  The auditor should not therefore rely on a certificate from a broker stating that he holds the company’s securities.


The auditor should carry out the following tests:

  • Examine certificates of title and confirm that they are bona fide complete title documents in the client’s name and free from any charge or lien.
  • Examine confirmation from a third party investment custodian and check investments are in the client’s name and the investments are free from charge or lien.
  • Inspect certificates of title held by third parties who are not bona fide custodians.
  • Inspect blank transfers and letters of trust to confirm client owns nominee shares.
  • Review minutes and other statutory books for evidence of charging and pledging.
  • Verify purchases to agreements, contract notes and correspondence.
  • Confirm purchases were authorised.
  • Check with appropriate financial data suppliers that all reported capital changes, bonus or rights issues have been correctly accounted for during the year.
  • Verify disposal with contract notes and sales agreements.
  • Check whether investments disposals have been authorised.
  • Confirm that profit or loss on sale of investments have been correctly calculated taking into account, bonus issue of shares, consistent basis of identifying cost of investment, rights issues, accrued interest, taxation.
  • The auditor should establish that the company’s policy on valuing investments has been correctly applied and is consistent with previous years.

Confirm the value of listed investments by reference to stock exchange listings.

Review accounts of unlisted companies and assess the net assets value of the shares and the value of the investment and ensure that it is reasonable.

Check that no substantial fall in the value of the investments has taken place.

  • Check whether the current asset investments are included at the lower of cost or net realisable value.


Investment income

The basis of recognising investment income may vary from company to company particularly for dividends.  Credit may be taken only when received, when declared or taken only after ratification of the dividend by the shareholders in general meeting.  Whichever is the basis, a consistent one must be applied from year to year.


The auditor will be concerned with completeness, occurrence and measurement.  To address these issues he should:

  • Check that all income due has been received by reference to financial statements for unlisted companies and other available financial data.
  • Review investment income account for irregular or unusual entries.
  • Ensure that the basis of recognising income is consistent with previous years.
  • Compare investment income with prior years and explain any significant fluctuations.
  • Obtain a statement reconciling the book value of the listed and unlisted investments at the last balance sheet date and the current balance sheet date.
  • Ensure that the investments are properly categorised in the financial statements into listed and unlisted.


Investment properties

IAS 40 sets out the criteria for the validity of an investment property.  It is property, whether land or buildings, held rather than for use in the ordinary course of business. There are different standards applicable depending on the type of the property:

  • Property held for sale in ordinary course of business – IAS 2 inventories
  • Property being constructed on behalf of third parties – IAS construction contracts
  • Owner occupied property – IAS 16 property plant and equipment
  • Property being constructed for future use as investment property – IAS 16 until construction or development is completed, then treat as an investment property.


The auditor should do some substantive testing:

  • Verify rental agreements, ensuring that occupier is not a connected company and that the rent has been negotiated at arm’s length.
  • If the building has recently being built, check the architects certificate to ensure that the construction work has been completed.
  • IAS requires that investment properties either be held at cost or at fair value. The auditor should verify this to a valuer’s cert., as professional valuation is encouraged under the IAS.
  • The auditor should seek to verify the cost to appropriate evidence such as purchase invoice, or if self constructed, costing records, payroll etc.
  • The auditor should review the disclosures made in the financial statements in relation to investment properties to ensure that they have been made appropriately, in accordance with IAS 40.



The audit objectives for liabilities are completeness, rights and obligations and existence.  Liabilities must always be tested for understatement.



The classification of a lease can have a material effect on the financial statements.

There are two main types of leases, finance leases and operating leases.

IAS 17 defines a lease as an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.


A finance lease is a lease that transfers all the risks and rewards of ownership of an asset.

Title may or may not eventually be transferred.

An operating lease is a lease other than a finance lease.


The standard requires that a finance lease should be recorded in the balance sheet of a lessee as an asset and as an obligation to pay future lease payments.  At the inception of the lease the sum to be recorded both as an asset and a liability should be the fair value of the leased property or if lower, the present value of the minimum lease payments.


It also requires that the rentals under an operating lease should be written off as an expense on a straight-line basis over the term of the lease even if the payments are not made on such a basis, unless there is another rational basis that is justified in the circumstances.


If the lease is a finance lease, the balance sheet will show substantial assets and liabilities.  The overall net effect would be marginal but the balance sheet will be materially different if the lease was an operating lease.


The following audit procedures are relevant;

  • Obtain a copy of the lease agreement and review it for the correct classification.
  • Obtain the client’s workings in relation to finance leases.
  • Check the additions and calculations of the workings
  • Ensure the interest has been accounted for in accordance with the standard.
  • Agree the opening the position to previous year’s audit file.
  • Verify the lease payments in the year to the bank statements.
  • The auditor should ensure the lease has been properly disclosed.


Deferred taxation

 The auditor should review the movement on the deferred tax provision.  Deferred tax is accounted for under IAS 12, income taxes, and is defined as:

Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences.

Deferred tax assets are the amounts of the income taxes recoverable in future periods in respect of deductible temporary differences, unused tax losses and credits carried forward.


Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax written down value.  All taxable temporary differences give rise to a deferred tax liability and all deductible temporary differences give rise to a deferred tax asset.


Deferred tax is the tax attributable to timing differences.  A company saving tax in the current period by having accelerated capital allowances should have a provision for the tax charge in the balance sheet.


The provision is essential because over the life of the asset the tax allowances will reduce until the depreciation in the accounts is higher than the allowances.  This will result in taxable profits being higher than reported profit and the company will suffer higher tax in this period.

The provision may be material depending on the company’s future investment plans and therefore the extent to which the tax liability will crystallise.


There is a degree of estimation involved in the deferred tax provision. Therefore the auditor should approach his work bearing in mind that this is an area that could be manipulated by the directors.  A deferred tax charge appears on the profit and loss account before dividends even if it is not actually paid.


The following audit procedures will be relevant:

  • Obtain the deferred tax workings and the corporation tax computations.
  • Check the accuracy of the workings on deferred tax.
  • Agree the source figures for timing differences to tax computations and financials.
  • Discuss the assumptions made about future events with the directors.
  • Consider the assumptions made in the light of your knowledge of the business and any other evidence gathered during the course of the audit to ensure reasonableness.
  • Agree the opening position of deferred tax to prior year financial statements.
  • Review the basis of the provision to ensure that it is in line with accounting practice is suitably comparable to practice in previous years and any changes in accounting policy have been disclosed.


Provisions and contingencies

 A provision should be accounted for as a liability.  Contingencies should be disclosed.  The auditor needs to ensure there has been correct classification according to IAS 37: provisions, contingent liabilities and contingent gains.


IAS 37 defines a provision as a liability of uncertain timing or amount.

A liability is a present obligation of an enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise.

An obligation is an event that creates a legal or constructive obligation that results in an enterprise having no realistic alternative to settling that obligation.

A legal obligation derives from a contract through its explicit or implicit terms, legislation or some other operation of law.

A constructive obligation derives from established patterns of past practice or published policies through which a valid expectation is created on the part of another party.


A contingent liability is a:

  • possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise or
  • a present obligation that arises from past events but is not recognised because it is not probable that an outflow of resources will be required to settle the obligation or the amount of the obligation cannot be measured with sufficient reliability.


A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.


Provisions and contingent liabilities:

Under IAS 37, an entity should not recognise a contingent asset or a contingent liability.  However, if it becomes probable that an outflow of future economic benefits will be required, then a provision should be recognised.  A contingent asset should not be accounted for unless its realisation is virtually certain.  If an inflow of economic benefits has become probable, the asset should be disclosed.

  • Where there is a present obligation that probably requires an outflow of resources, then a provision should be recognised and disclosed.
  • Where there is a possible or present obligation that may, but probably will not, require an outflow of resources then no provision should be recognised but disclosures are required for the contingent liability.
  • Where there is a possible or present obligation where the likelihood of an outflow of resources is remote, then no provision is recognised and no disclosure is required.


A contingent liability also arises in the rare case where there is a liability that cannot be recognised because it cannot be measured reliably.  Disclosures are required in this instance.


Contingent assets

  • Where the inflow of economic benefits is virtually certain, the asset is not contingent.
  • Where the inflow of benefits is probable but not virtually certain, then no asset is recognised but disclosures are required.
  • Where the inflow is not probable, then no asset nor disclosures are recognised.


Examples of contingencies disclosed by companies are guarantees for other group companies, staff pension schemes, completion of contracts, discounted bills of exchange, law-suits or claims pending and options to purchase assets.


Obtaining audit evidence of contingencies

The auditor should carry out audit procedures in order to become aware of any litigation and claims involving the entity, which may result in a material misstatement of the financial statements. Such procedures would include the following:


  • Make appropriate inquiries of management including obtaining representations.
  • Review minutes of management meetings and correspondence with the solicitors Examine legal expense accounts.
  • Use any information obtained regarding the entity’s business including information obtained from discussions with any in-house legal department.


When the auditor assesses a risk of material misstatement regarding litigation or claims that have been identified or when the auditor believes they may exist, the auditor should seek direct communication with the entity’s legal counsel.


This will help to obtain sufficient appropriate audit evidence as to whether potential material litigation and claims are known and management’s estimates of the financial implications, including costs are reliable.


The letter, which should be prepared by management and sent by the auditor, should request the entity’s legal counsel to communicate directly with the auditor. When it is considered unlikely that the entity’s legal counsel will respond to a general inquiry, the letter would ordinarily specify the following:


  • A list of litigation and claims
  • Management’s assessment of the outcome of the litigation or claim and its estimate of the financial implications, including costs involved.
  • A request that the entity’s legal counsel confirm the reasonableness of management’s assessments and provide the auditor with further information if the list is considered by the entity’s legal counsel to be incomplete or incorrect.


The auditors must consider all matters up to the date of their audit report so further contact may be necessary with the solicitor.  This can only take place with the permission of management and may be required where a disagreement/complex matter arises.


If management refuses to give the auditor permission to communicate with the entity’s legal counsel, this would be a scope limitation and could lead to a qualified/disclaimer of opinion.


Where the entity’s legal counsel refuses to respond in an appropriate manner and the auditor is unable to obtain sufficient appropriate audit evidence by applying alternative audit procedures, the auditor should consider whether there is a scope limitation that may lead to a qualified opinion or a disclaimer of opinion


Other audit tests that should be carried out on provisions and contingencies are as follows:

  • Obtain details of all provisions that have been included in the accounts and all contingencies that have been disclosed.
  • Obtain a detailed analysis of all provisions showing the yearly movements.
  • Determine for each material provision whether the company has a present obligation as a result of past events by review of correspondence and discussion with directors.
  • Determine for each material provision whether it is probable that a transfer of benefits will be required to settle the obligation by checking whether any payments have been made in the post balance sheet period in respect of the item and review of correspondence with solicitors, banks, customers insurance company and suppliers.
  • Recalculate all provisions made and assess their reasonableness.
  • Compare the amount provided with post year-end payments and with any amount paid in the past for similar items.
  • In the event that it is not possible to estimate the amount of the provision, check that there is disclosure in the accounts.
  • Consider the nature of the client’s business; for example would you expect to see any other provisions such as warranties.
  • Consider the adequacy of disclosure of provisions and contingencies.



Revenue recognition is an important issue and measurement is the key audit objective. IAS 18 covers revenue from specific transactions or events:

  • Sale of goods,
  • Rendering of services,
  • Interest, royalties, dividends.


Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an enterprise when those inflows result in increases in equity other than increases relating to contributions from equity participants.

Fair value is the amount for which an asset could be exchanged, or a liability settled, between willing parties in an arm’s length transaction.


Accounting treatment of Income


Income should be measured at the fair value of consideration received, net of trade discounts/volume rebates.  It is the norm to identify income related items usually as a whole, but you may need to break the transaction down into its components parts or put separate transactions together to obtain commercial meaning.


Sale of goods


An enterprise should only recognise income in relation to the sale of goods when:

  • Significant risks and rewards of ownership of goods are transferred,
  • There is no continuing managerial involvement over goods,
  • Revenue can be measured reliably,
  • It is probable that economic benefit will flow to an enterprise, Costs incurred can be measured reliably.

Rendering of services


An enterprise should recognise revenue of services depending on the stage of the completion of the transactions.  The outcome can only be reliably estimated when:

  • Revenue can be measured reliably,
  • Probable economic benefits will flow to enterprise,
  • Stage of completion at balance sheet date can be measured reliably,
  • Costs incurred can be measured reliably. Reliable estimates will only be possible when each party’s enforceable rights and the terms of settlement have been agreed.

Interest, royalties and dividends


Interest is the charge for the use of cash/cash equivalents or amounts due to the enterprise. Royalties are charges for the use of long-term assets of the enterprise such as patents, computer software and trademarks.

Dividends are distributions of profits to holders of equity investments, in proportion with their holdings, of each relevant class of capital.


Revenue should be recognised when it is probable that economic benefits will flow to enterprise and the revenue can be measured reliably.

Interest should be recognised on a time proportion basis, Royalties on an accruals basis or per agreement and Dividends when shareholders gain right to receive payment.



There should be disclosure of the accounting policy, the amount of each significant category of income and any contingent gains or losses.


Revenue is normally audited by analytical review.  This is because revenue is predictable and there are good sources on which to base analytical review such as last year’s accounts and the existence of logical relationships with items such as inventory and receivables.


Revenue recognition can be influenced by whether you are acting as a principal or as an agent.  In the latter, you will only recognise the commission.


Government grants and assistance (IAS 20)

These payments can take the form of grants relating to assets or income.


Government assistance is action by government designed to provide an economic benefit specific to an enterprise or range of enterprises qualifying under certain criteria.

They can be in the form of resources in return for past or future compliance with certain conditions relating to the operating activities of an enterprise.


Grants related to assets are those whose primary condition is that an enterprise qualifying for them should purchase, construct or otherwise acquire long-term assets.  Conditions may also be attached restricting the type, location, or periods acquired or held.


Grants related to income are grants other than those related to assets.

Forgivable loans are where repayment is waived under certain prescribed conditions.


Accounting treatments:

  • Recognise grants/forgivable loans once conditions are complied with and receipt/waver is assured.
  • Recognise grants as income to match them with related costs.
  • Use a systematic basis of matching over the relevant period.
  • Recognise grants for depreciable assets as income on same basis as asset is depreciated.
  • Where related costs are incurred the grant may be recognised as income immediately.
  • A grant in the form of a non-monetary asset may be valued at fair value.
  • Grants related to assets may be presented in the balance sheet 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 income statement either as a separate credit or deducted from the related expenses.



There should be disclosure of the accounting policy, the nature and extent of government grants and other forms of assistance received.


The auditor should carry out some of the following procedures:

  • Obtain grant documentation and ensure correct classification as either revenue or capital.
  • The value may be agreed to documentation such as a grant letter.
  • The receipt of the grant can be agreed to bank statements.
  • The auditor should consider whether the basis of accounting is comparable to the previous year, discuss the basis of accounting with the directors to ensure that the method used is the best method.
  • Ensure that any changes in accounting methods are disclosed.




Borrowing costs may sometimes be capitalised as part of an asset.


IAS 23 deals with the treatment of borrowing costs.  It is often associated with the construction of or self constructed assets but can also be applied to an asset purchased that takes time to get ready for use and/or sale.


Borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds.

A Qualifying asset is an asset that may take a substantial period of time to get ready for its intended use or sale.


Accounting treatments:

  • Recognise borrowing costs as an expense in the period incurred or
  • Capitalise as part of the cost of an asset if they are directly attributable to acquisition/construction/production. Other borrowing costs must be expensed.
  • The amount of borrowing costs available for capitalisation are actual borrowing costs incurred less any investment income from temporary investment of those borrowings.
  • Capitalisation is suspended if active development is halted for extended periods. Temporary delays do not cause suspension.
  • Capitalisation ceases when physical construction of the asset is completed. Capitalisation should cease when each stage or part is completed.
  • Where the carrying amount of the asset falls below cost, it must be written down/off.



There should be disclosure of the accounting policy, the amount of borrowing costs capitalised during the period and the capitalisation rate used to determine borrowing.

Audit procedures


The interest can be audited by analytical review as it has a predictable relationship with loans such as bank loans or debentures.

Alternatively, it can be verified to payment records, bank statements and loan agreement documentation.


Where borrowing costs are capitalised the auditor should:

  • Agree interest payments made to statements from lenders and /or bank statements.
  • Ensure interest is directly attributable to construction.



The auditor must ensure disclosures in the financial statements are fairly stated.

Segment reporting


IAS 14 defines a business segment as a distinguishable component of an enterprise that is engaged in providing an individual product or service or a group of related products or services and that is subject to risks and returns that are different from those of other business segments.  Factors to be considered in determining whether products and services are related include:

  • The nature of the products or services or the production processes,
  • The type or class of customer for the products or services,
  • The methods used to distribute the products or provide the services,
  • The nature of the regulatory environment such as banking, insurance or public entities.


Factors that should be considered in identifying a geographical segment include:

  • Similarity of economic and political conditions,
  • Relationships between operations in different geographical areas,
  • Proximity of operations,
  • Special risks associated with operations in a particular area,
  • Exchange controls regulations,
  • Currency risks.


The following audit procedures are relevant:

  • Obtain a schedule of turnover workings,
  • Discuss with management the basis for the segmentation,
  • Verify a sample of items to source documentation to ensure disclosure is correct.

Earnings per share


Accounting for earnings per share is governed by IAS 33.  It requires that companies of a certain size disclose their earnings per share for the year.  This is the profit in Rwandan Franc attributable to each share.

While the size of the figure is unlikely to be a material amount, it is a key investor figure and as a result will be material by its nature.


The auditor must consider two issues:

  • Whether EPS has been disclosed on a comparable basis to the prior year and have any changes in accounting policy been disclosed and
  • Whether it has been correctly calculated.


The audit procedures are as follows:

  • Obtain a copy of the client’s workings. If a simple calculation has been used this can be checked by doing a calculation on face of the profit and loss.
  • Compare the calculation with prior years to ensure that the basis is comparable.
  • Discuss the basis with the directors. If it has changed, assess whether it is the best basis for the accounts this year and that changes have been adequately disclosed

Discontinued operations

IFRS 5 requires that certain disclosures be made for discontinued operations on the face of the income statement or in the notes.  This is likely to be material due to size and a possible shift in management policy or a major change in focus of operations.  This information is of interest to shareholders.


The auditor must be aware of the implications of IFRS 5 for the financial statement at all stages of the audit whether planning stage, during substantive testing or at the review stage, particularly in terms of the going concern assumption.


To audit whether the disclosures have been made correctly, the auditor should:

  • Discuss the disclosure with management to ensure that IFRS have been correctly applied,
  • Review minutes and correspondence to ascertain details of discontinued operations,
  • Obtain a copy of the client’s workings to disclose the discontinued operations,
  • Review the workings to ensure figures are reasonable and agree to the financials,
  • Trace sample of items disclosed as discontinued items back to source documentation.


Cash flow statements


Cash flows are accounted for under the provisions of IAS 7.  The cash flow statement is essentially a reconciliation exercise between items on the profit and loss account and the balance sheet.


The cash flow statement is usually audited by the auditor reproducing it from the audited figures in the financial statements.  This is facilitated by the use of computer systems.


The cash flow statement may indicate going concern problems due to liquidity failings overtrading and over-gearing.  As the statement is an historical document it is therefore unlikely to be the first indicator of such going concern issues.

Question 10.2


ACE manufactures football kits.  It has contracts with a number of premiership teams and it also produces unbranded football kit which it sells to a number of wholesalers.


The profit before tax for the year ended 30 June 2010 is RWF1.5m (RWF4.0m 2009).  You are the audit manager and today you have visited the client’s premises to review the work of the audit team.  The audit senior has drafted the following points for your attention.


ACE is seeking to enter the market in women’s leisure clothes and so during the year it purchased 35% of the share capital of Ladies LTD at a cost of RWF800k.


During the year a major competitor emerged in the branded football kit market.  Two of the contracts with premiership clubs which came up during the year have not been renewed.  A number of key personnel within the company have also been headhunted by this competitor.


Legislation was passed in Dec 2009 to adjust the seats at which operators sit.  It required the seats to be adjusted by April 2010.  The company has not yet carried out any of this work.  Also in April 2010, the government increased the national minimum wage.  It should be noted 5% of the company’s employees receive less than the minimum wage.


As the audit manager comment on the matters you would consider and state the evidence you would like to see during your review of the working papers and the financial statements.

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