How to Audit Intangible Assets?

Intangible assets are the assets that company owns but they lack physical substance. Even though they are not physical in nature, they are identifiable and separate from each other. The intangible assets include copyright, patent, goodwill, and so on.

The intangible assets with defined useful life will require to depreciate the same as the fixed assets. The process is called amortization which will reduce the balance of intangible assets from the balance sheet and increase the amortization expense on income statement. At the end of useful life, the intangible assets will decrease to zero. They do not have any scrap value which is different from the fixed assets.

It sounds confusing when auditor performs an audit on assets that do not have physical substance. They will not be able to perform physical inspection, but they still are able to validate their existing.

The auditor who tests the intangible assets should be the same person who tests the amortization expense as well. He will not require to understand the same process twice, it will save time and increase the chance of detecting material misstatements.

Audit Assertion for Intangible Assets

  • Existence: The intangible assets must exist so the company can record them on the balance sheet.
  • Right and Obligation: It shows that the company record the intangible assets that they have the right to use. It does not make sense to record the assets when we cannot.
  • Completeness: The company has obligation to record all the intangible assets in the report. For whatever reasons, they must not remove them as long as they are under company control.
  • Accuracy and valuation: The recording must show the real value of intangible assets.
  • Classification & Presentation: The company has to present intangible assets in the right classification otherwise it will mislead the user. Additional disclosure will be useful for the reader such as the movement during the year.

Substantive Analytical Procedure for Intangible Assets

Most of the time, auditors always perform the analytical producer as the tool to help get more information between all accounts on the financial statement. It also helps us to see the connection between financial and non-financial data as well.

The intangible assets are not the common assets for every company. It does not make sense for a small company to own intangible assets. They are less likely to develop their own software in-house. Moreover, not all the companies own the trademark as well. Based on this judgment, auditor can detect the unusual intangible assets and select the high-risk items.

Goodwill only arises from the business combination. It is only presented on the consolidated financial statement. It will be a possible misstatement if the goodwill is recorded while the company never goes through the business combination.

Any sudden increase in intangible assets can be an indicator of fraud or error on the balance sheet. The company may be making some mistakes related to the classification of assets. Some companies wish to record the self-generated intangible assets which may not be qualified.

Similar to fixed assets, the auditors prepare the movement during the year and analyze each component. The ending balance arrives from the opening balance plus new acquire and less the write-off during the year.

The opening can be cross-checked with last year’s financial report. The cost will be supported by the acquisition document such contract or agreement. They can rely on prior-year reports or perform a review if necessary.

The amortization expense will present on income statement and tested separately. Auditors can gross check in the amortization expense section if any misstatements exist.

The disposal and new purchase of intangible assets also require testing if the amount is material. They can be ignored if the amount is really low compared to the total amount.

Auditor should keep an eye open for any indication of impairment. The test of detail will not be able to detect the impairment of intangible assets such as goodwill. Auditors have to compare the relevant information from both financial and nonfinancial to conclude if the intangible assets are impaired or not. They have to focus on the future economic benefit that an entity can receive from the assets. If no such benefit, it is can be an indicator that the intangible assets are impaired.

Test of Detail for Intangible Assets

  • Existence: The auditor has to validate the existence of company intangible assets. For sure they cannot perform the physical inspection if compare to fixed assets. However, there are alternatives to check if the assets really exist.

Auditor can inspect the related document to prove the assets really exist. For example, they inspect the legal document for trademarks, patents, and licenses.

Auditor can inspect if the software really exists, and they have to check the supporting document if the software really belongs to the company.

  • Right and Obligation: Company must be the owner of intangible assets when they record them on the balance sheet.

Auditors have to review the legal document that proves that the company has the right to use assets. The documents can be the agreement with third parties, purchase invoices, and other official documents.

  • Completeness: The company must record all the intangible assets in the financial statement.

Auditor has to obtain intangible assets listing and reconcile it with the balance sheet. They have to reconcile the beginning balance and compare it with last year’s report. Then they reconcile the new purchase and disposal if there are any. They have to make sure all assets are really included.

  • Accuracy and valuation: The intangible assets balance must accurately represent the real value. The netbook value includes the purchase cost less accumulated amortization.

Auditors must validate the acquisition cost and accumulated amortization expense which will be used to calculate the net book value at year-end.

However, they reduce the workload by testing only the new purchase/disposal during the year by only reconciling the opening balance with last year’s report.

The amortization expense will be tested under its own section on income statement.

The final step is to combine all the figures together. The ending balance is equal to the beginning balance plus new purchase less amortization expense and disposal. If every component is correct, the final figure is also correct.

  • Classification & Presentation: The total intangible assets must be properly classified and presented on the balance sheet to prevent any confusion.