Auditing intangible assets and development costs
How to audit intangible assets under IAS 38, including capitalised development costs, items that can never be assets and those with indefinite lives.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
A fintech start-up in Lagos capitalises its developers' salaries as "platform development". A Nairobi media company carries a customer list it built itself. A Durban manufacturer has bought a trademark from a competitor. All three show intangible assets, and only one of them is straightforward.
Intangibles cannot be counted or touched, and many of the costs behind them would otherwise be expenses. That makes them an attractive place to park costs and lift profit, sometimes deliberately and often through a well-meant misunderstanding of the rules. This article sets out how to audit intangible assets under IAS 38, with particular attention to development costs.
The definition: identifiable, controlled, bringing future benefits
The IFRS Foundation summarises IAS 38's definition: an intangible asset is an identifiable non-monetary asset without physical substance. It is identifiable when it is separable or when it arises from contractual or other legal rights. The examples IAS 38 gives include computer software, licences, trademarks, patents, films, copyrights and import quotas.
Under IAS 38, expenditure on an intangible item is recognised as an expense unless three conditions are met: the item meets the definition of an intangible asset, future economic benefits from it are probable, and its cost can be measured reliably.
For each class of intangible on the client's register, the auditor's first job is to test those conditions:
- Identifiable? Can it be sold or licensed separately, or does a contract or law give the client rights over it?
- Controlled? Does the client, rather than an employee or a partner, hold those rights?
- Future benefits? Is there a realistic route to revenue or savings from it?
- Reliable cost? Can the client show what it spent, from invoices or time records?
For purchased intangibles, inspect the purchase agreement and evidence of payment. For licences and rights, read the terms, including duration and renewal.
Research expensed, development capitalised only on the criteria
IAS 38 draws a firm line. Research expenditure is recognised as an expense. Development expenditure that meets specified criteria is recognised as the cost of an intangible asset.
The criteria are set out in the standard itself, and the auditor should test the client against the full text rather than a summary. In practice the questions are about evidence:
- Has the project moved from research into development? Find the date and the evidence: a working prototype, a design approved for build, a decision to proceed.
- Is it technically feasible and does the client intend and have the resources to complete it? Look for budgets, funding and project plans approved by the board.
- How will it generate benefits? A market for the product, or internal use that brings savings.
- Can the costs be measured? Time records for staff whose salaries are capitalised, invoices for contractors, and an allocation method that is applied consistently.
Costs incurred before the criteria were met stay as expenses, even if the project later succeeds. Test the start date of capitalisation carefully, because that is where overstatement usually begins.
Internally generated items that are never assets
IAS 38 states that internally generated brands, mastheads, publishing titles, customer lists and similar items are not recognised as intangible assets, and that internally generated goodwill is not recognised as an asset.
That gives the auditor a short list of items to look for and reject. A company that has capitalised the cost of building its own brand, or the value of a customer database it grew itself, has an asset IAS 38 does not allow. The same items bought from a third party can be assets; built internally, they cannot. Ask how each item on the register arose.
Amortisation and indefinite lives
Under IAS 38, intangible assets are measured initially at cost and, after recognition, usually at cost less accumulated amortisation. The standard allows fair value in rare cases, where fair value can be determined by reference to an active market. If the client uses fair value, ask what the active market is; for most intangibles there is none.
An intangible asset with a finite useful life is amortised and subject to impairment testing. One with an indefinite useful life is not amortised, but is tested for impairment every year.
Audit points:
- Useful lives. Compare with legal or contractual terms, expected use and how quickly the technology dates. Software rarely lasts as long as clients hope.
- Start of amortisation. Development costs start to amortise when the asset is available for use, not when the project finishes on paper.
- Indefinite lives. Challenge any claim that a life is indefinite. Ask what would have to be true for the benefits to continue without limit.
- Recalculation. Recompute the amortisation charge for each class.
Recording procedures and adjustments in Achekam
Each work item in Achekam carries a panel listing the procedures to perform and the documents required. A procedure counts as done only once it has a written response and its documents, or it is set aside with a reason; nothing is deleted. For intangibles, that means the capitalisation criteria test, the start-date evidence and the useful-life challenge each sit as their own step, with their support attached.
The intangible asset lines in the lead schedules come from the engagement's trial balance and trace to the lines behind them. Where the team concludes that research costs or an internally generated customer list have been capitalised, staff record an audit adjustment on the line with a reason, and raise a finding from the working paper that is closed or withdrawn later.
The link to impairment testing
Intangibles and impairment are tightly connected. Indefinite-life intangibles and assets not yet available for use need an annual impairment test, and capitalised development projects that have stalled or lost their market are a classic indicator. When the development criteria were met in the past but the product has not sold, test recoverability before accepting the carrying amount. See auditing property, plant and equipment for the asset register work, and auditing accounting estimates for challenging useful lives and forecasts.
The IFRS Foundation's summary of IAS 38 Intangible Assets covers the definition, the research and development split and the treatment of internally generated items, and is the starting point before reading the full criteria.
At your next client with capitalised development, ask at planning for the date each project met the development criteria and the evidence for it. If nobody can name the date, that is where your testing starts.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
