Question

Highnix ’s research and development expenditure.

Highnix Electronics Sdn Bhd develops and manufactures computer components and its year end was 31 December 2018 . The company has a large factory, and two warehouses, one of which is off-site. You are an audit supervisor of Tipah & Co and the final audit is due to commence shortly. Draft financial statements show total assets of RM23.2m and profit before tax of RM6.4m. The following three matters have been brought to your attention:

Inventory valuation

Your firm attended the year-end inventory count for Highnix Electronics and confirmed that the controls and processes for recording work in progress (WIP) and finished goods were acceptable. WIP and finished goods are both material to the financial statements and the audit team was able to confirm both the quantity and stage of completion of WIP.

Before goods are dispatched, they are inspected by the company’s quality control department. Just prior to the inventory count, it was noted that a batch of product line ‘Crocus’, which had been produced to meet a customer’s specific technical requirements, did not meet that customer’s quality and technical standards. This inventory had a production cost of RM450,000. Upon discussions with the production supervisor, the finance director believes that the inventory can still be sold to alternative customers at a discounted price of RM90,000.

Research and development

Highnix Electronics includes expenditure incurred in developing new products within intangible assets once the recognition criteria under MFRS138 Intangible Assets have been met. Intangible assets are amortised on a straight line basis over four years once production commences. The amortisation policy is based on past experience of the likely useful lives of the products. The opening balance of intangible assets is RM1.9m.

In the current year, Highnix Electronics spent RM0.8m developing three new products which are all at different stages of development.

Sales tax liability

Highnix Electronics is required by the relevant tax authority in the country in which it operates to charge sales tax at 10% on all products which it sells. This sales tax is payable to the tax authority. When purchasing raw materials and incurring expenses in the manufacturing process, the company pays 10% sales tax on any items purchased. The company is required to report the taxes charged and incurred by completing a tax return on a quarterly basis, and the net amount owing to the tax authority must be remitted within two months. The draft financial statements contain a RM1.1m liability for sales tax for the quarter ended 31 December 2018 .

Required:

Describe any SIX substantive procedures each, the auditor should perform to obtain sufficient and appropriate audit evidence in relation to

Highnix ’s research and development expenditure.

Answer 1

Substantive audit procedures are procedures designed to obtain direct evidence as to the completeness, accuracy and validity of data, and the reasonableness of the estimates and other information contained in the financial report.

Substantive procedures include

1.Inspection,

2.Observation,

3.Enquiry,

4.Confirmation,

5.Recalculation,

6.Re-performance,

7.analyses nd analytical reviews.

The combination of inherent risk and control risk determines the level of detection risk the auditor is willing to accept and to still be able to conclude that the financial report is materially correct. Detection risk is reduced or increased in direct proportion to the amount of substantive testing performed. There are several factors that influence how much substantive testing is performed including the nature of the test, the level of assurance necessary, the type of evidence required and the complexity of the client's data capturing systems. The timing of substantive procedures is most flexible when controls have been tested and assessed as effective, and can be performed up to six months before year-end. When controls are not tested or are not assessed as effective, the timing of substantive procedures is at or near year-end.

Below are the Substantive audit procedures, the auditor should perform to obtain sufficient & appropriate audit evidene in relation to Highnix's Research & Development Expenditure :

1. Determine that the intangible assets exist by reviewing appropriate documentation, for example, legal documentation (in the case of a license or patent).

2. Determine that the intangible assets are owned by the Highnix Electronics Sdn Bhd by inspecting relevant documentation, such as the purchase agreement or sales agreement.

3. Test management’s calculation of any gain or loss on the disposal of intangible assets and determine whether the carrying amounts have been properly reduced.

4. For amortizable intangibles with finite lives, determine whether amortization expense is accurate and whether the amortization policy and useful lives are reasonable and consistent with prior years.

5. Inquire of management about whether circumstances indicate that the carrying amounts of intangibles (which are subject to amortization) may not be recoverable. also evaluate mangament's impairment testing and conclusion regarding the write-off.

6. Carefully scrutinize appraisals and other specialist reports that seem out of line with reasonable expectations, and challenge the underlying assumptions. Use the work of a specialist for asset valuations, including impairments.